Interest rates could still fall

Paul Dales the Chief Economist at Capital Economics explains why they believe the RBA could cut interest rates to 1.0% later this year

Interest Rates Could Still Fall

Introduction

Ross: Great to have your company here on Money News right around Australia. No surprise. The Reserve Bank kept interest rates on hold at 1½% or even going out to next year. You’ll see that most economists still believe interest rates will be on hold, that’s around about a third or a little over a third of economists. Just under a third think that interests rates will be higher and around about a third think that interest rates will be lower than what they are. So in other words, how do you make a decision when the economists are all split on what the direction of interest rates are?

The one thing that’s occurred is that the banks have taken matters into their own hands. To try and cool down the housing markets and their own pace of lending, they have started to move interest rates around especially for investors. But looking underneath where the Reserve Bank is right now and where it comes to interest rates, let’s try and get the latest on this from the Chief Economist of Australia and New Zealand at Capital Economics, Paul Dales, who’s on the line right now. Many thanks for your time, Paul.

Paul Dales: My pleasure.

Interview

Ross: No surprise about this but the Reserve Bank in its statement today certainly talked about the level of property values in Australia. It also raises again question marks about household debt and particularly those taking on big mortgages to buy the property at these levels. This is an increasing part of the rhetoric of not only regulators, but also others in the community as well.

Paul: That’s right. I mean the RBA has been keeping interest rates low in order to boost inflation, boost the economic growth, and to lower the unemployment rate. But a consequence of that has been rapid growth in house cost inflation and household debt and that does pose some risks to the economy further down the road.

But I think the change today, which is an important element, was that the RBA seems to be becoming a little less worried about that. It placed quite a lot of emphasis in its policy statement today on the tightening in regulatory rules on mortgage lending that was announced last week. It seems to be the case that perhaps the RBA is now thinking, “Well, we don’t need to worry quite as much about the risk to household debt or the housing market if the regulators are forcing the banks to lend more prudently.”

Ross: So that being the case, of course, you’ve now got a situation where when you look around and say for example, look at where rates might go into the future, and we go even to your own organization, you still believe that rates will go down. Now, most people are saying interest rates is going up from their banks, particularly if they are investors right now or even in business. Just explain the rationale between your ongoing forecast that you believe interest rates could come down even by 50 basis points, half a percent from where they are today.

Paul: Well, there’s two developments that I think could prompt the RBA to reduce interest rates again. The first is some news that suggests that underlying inflation in the economy is weaker than it expects and/or the unemployment rate is higher than it believes it would be, and I think we’ll probably get that within the next three to six months.

The second part is some easing in the RBA’s concerns about the risks that the economy in the future pose behind the high level of household debt and the whole housing market. I suspect that the tightening in lending conditions that the regulatory authorities and at the end of last week will result in those risks easing or the RBA’s concerns about that fact of easing later in the year.

So putting those two things together, I think the RBA will become more worried about low inflation and less worried about the housing market. That would give it a greener light to cut interest rates in order to try and boost inflation and lower the unemployment rate quicker.

Economic Growth Becomes Stagnant

Ross: The other aspect of this is that economic growth is likely to be relatively stagnant at least for the short term while the aftermath of cyclone Debbie and the significant storms and the floods that have gone through Northern New South Wales and into Queensland also go through the system because the impact on economic growth and the agricultural sector especially, is going to be significant.

Paul: Yes, I think that will certainly play some part in influencing the economic data over the next couple of quarters. It’s the shortage of some key crops such as fruits is going to boost inflation and the closure of many mines, for example, tourist companies will mean that economic growth will be weaker. But it’s important to note that these are just temporary effects. After a few months or so, economic activity will bounce back and inflation will fall back. So this changes, they makes the path a bit bumpier, but the overall destination is the same. That’s an economy where economic growth isn’t strong enough, inflation is too low.

Ross: Paul Dales, the Chief Economist of Australia and New Zealand of Capital Economics, one of the economists who still believes that interest rates are going to fall and, Paul, we appreciate your time.

Paul: Thanks very much.

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