Hedge Clippings | Friday 26 April, 2019

Reading the press - or more accurately the media as a whole - it seems many economists are predicting a rate cut from the RBA following their meeting on Tuesday week, May 7th.  However, we're not so sure - or at least not sure that it is either the right thing to do or will have the desired effect.

This of course begs the question, "what is the desired effect?". From what we can understand from the media, and even noted non-economist Bill Shorten, it seems low inflation is what is now the economy's major issue! Not so long ago it was high inflation.

The problem is that at 1.5% rates are already historically low, albeit higher than in many other developed countries, as is inflation. Negative rates across Europe haven't resulted in either an uptick in their levels of inflation or, more to the point, an improvement in their economic activity.

Dropping rates to 1.25% won't fix the problem, and Bill Shorten should be called out for advocating higher inflation as a solution to the Australian economy. Today's low inflation is not merely a result of low wages growth (although it helps); it's also a sign of a combination of falling power and energy prices; and increased productivity due to technology and increased competition, in part as a result of improved price discovery thanks to the internet.

In turn, the housing market is in a dive due to a combination of factors: 5 years of unconstrained price rises which created a bubble and an affordability crisis amongst new borrowers and low income earners, driven partly by offshore (particularly Chinese) demand; easy lending practices of the banks, and low interest rates. Dropping rates another 0.25% won't address the other causes, such as tightening of China's capital and exchange controls and the banks' new found reluctance to lend, and now the subsequent decline.

Two leading economists have suggested increasing infrastructure spending; i.e. fiscal, rather than monetary, stimulus as an alternative solution. That would be preferable to a blunt cut by the RBA who have less and less room to move, particularly just before an election where handouts - or at least promises* - seem to be falling from the sky. Tie that in with smart changes to super to ensure a portion of all super is directed towards long term investment in infrastructure, and maybe we'd be getting somewhere.

*P.S. Unless you have a short memory, beware politicians promising pre-election hand-outs. One lot won't need to keep theirs as they'll be in opposition post May 18th, and the others might have a short memory - or a well-practised bag of excuses - when it comes to keeping theirs.