RBA Analysis Of Market

The RBA spoke at the Corporate Finance Forum yesterday and highlighted the the nation’s and the world’s latest analysis following the drop in the interest and cash rates earlier this month.

“The first is a domestic one – that is, the transition in the Australian economy following a period of extraordinarily strong growth in investment in the resources sector combined with record high commodity prices.”

The second is a much more international one – and that is what seems to be a transition to a world in which global interest rates are lower, at least for an extended period, than we had previously become used to,” said Philip Lowe, Deputy Governor.

And whilst exports and commodity prices are showing promising leads, thank you China, the huge transition between natural resource exportation and our appealing property market  is concerning some. 

“In the middle of the previous decade, global commodity prices rose sharply, largely on the back of strong growth in China. In response, investment in the resources sector in Australia picked up considerably to take advantage of these high prices and Australia's endowment of natural resources, especially iron ore, coal and natural gas.”

The good news is that all this investment has considerably expanded Australia's capital stock, and thus our productive capacity.”

The low interest rates set out by the RBA seemingly, and primarily, effected the residential construction market the most.

“The third factor assisting with the transition is the low level of interest rates. The effects are perhaps clearest in residential construction which increased by 8 per cent in 2014. And with building approvals continuing at very high levels over recent months, particularly for apartments, we can look forward to further increases in construction activity over the months ahead,” Lowe continued. 

Low interest rates are also helping to boost household consumption. They are doing this by improving the aggregate cash flow of the household sector and boosting household wealth. However, as I have spoken about previously, the overall effect on consumption is probably smaller, or at least slower, than it was in the past. This is because high debt levels mean that households are less inclined than they once were to respond to low interest rates by borrowing to increase their spending. Notwithstanding this, there is still a spending response to low interest rates and household consumption rose by nearly 3 per cent in 2014. This is slower growth than in the period from the mid 1990s to the mid 2000s, but it is faster than current growth in real household income.

The part of the transition that is taking place more slowly than we had earlier expected is the lift in business investment outside the resources sector. As a share of GDP, non-mining business investment remains just above the levels reached in the recession of the early 1990s. For a few years now, each time we have updated our forecasts, we have pushed out the timing of the recovery in this part of the economy. The latest update was no different. Many businesses tell us that while conditions are okay at the moment, they are not sufficiently strong for them to lift their investment plans. Many feel uncertain about the future and so are waiting until there is a sustained pick-up in demand before committing to new capital expenditure.

There is no single factor driving this tendency to wait and a similar story seems to be playing out in many other advanced economies. Around the world, many businesses seem concerned about the prospects for consumer demand given high levels of debt and the ageing of the population. There is also uncertainty about what type of capital investment is appropriate in a world where new information technologies are reshaping business models. Many firms also see globalisation of markets as a challenge, especially where increased competition has reduced market power.”

Overall then, a lift in non-mining investment remains the critical ingredient to stronger growth in the overall economy and to a successful transition. Many of the preconditions for this to occur are in place, although a sustained lift still seems some way off. I will return to this issue in a few moments.

"In this challenging global environment, the RBA is seeking to play a constructive role. As I said earlier, low interest rates are supporting spending in the economy. The further reduction in the cash rate earlier this month will provide a bit more support and it will help reinforce some of the recent encouraging signs, particularly in household spending. In time, stronger consumption growth and a continuation of the pick-up in residential construction should lead to a lift in business investment.

It is, however, unlikely to be in Australia's long-term interests to engineer a consumption boom by encouraging people to borrow large amounts against future income. This is especially so when debt levels are already high and prospects for future income growth are not as positive as they once were. So, there is a fairly fine line to tread here. The RBA's recent decisions have sought to strike a prudent balance – to help encourage consumption growth and thus business investment, but avoid the type of imbalances that could cause problems later on. We will continue to assess that balance carefully.

Of course, the more enduring solution to the two issues I have talked about – the transition in the Australian economy and low returns to savers – is an improvement in the underlying investment environment. This is a challenge not just in Australia, but in almost all advanced economies. Unfortunately, there is no magic lever here, but the good news is that the task is not an impossible one!" concluded, the Deptuty Governor, Philip Lowe.