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Two more cash rate cuts to come

By Vivienne Kelly
Cash rate cuts in 2017
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Despite speculation that a Melbourne Cup Day cash rate cut will be the last of this cycle, a new report says it could go as low as 1 per cent next year.

Building activity will level off in 2016/17, according to QBE’s Housing Outlook 2016-19 report, and the subsequent weakening residential construction will combine with declining resource sector investment to “be a drag on the economy over 2017/18”.

Add to the mix the plateau in export growth, and thus its inability to contribute to economic growth, and something will be needed to stimulate the economy.

“Consequently, interest rates are forecast to be subject to one or two further cuts through 2017/18 to place further downwards pressure on the dollar,” the report said.

“The cyclical recovery is not expected to kick in until around the end of the decade, as the dwelling demand/supply balance beings to tighten, mining investment bottoms out, and non-mining business investment begins to return.”

A number of the RBA’s cash rate cuts so far have aimed to lower the Australian dollar, with moves by Australian Prudential Regulation Authority (APRA) to limit investor lending activity giving the central bank confidence this won’t in turn overinflate house prices, the report said.

Efforts to lower the Australian dollar, however, are being quashed by external forces.

“The economy is forecast to maintain growth around the current level. The low interest rate environment may not stimulate a substantial increase in GDP as house prices begin to plateau and growth in consumer spending slows on the back of low confidence levels. The intended move towards a lower Australian dollar which would boost exports is being hampered by global political and economic events.

“With strong acceleration in economic growth, it is expected that the underlying CPI rate will remain well within the RBA preferred band. Equally, the forecast waning resource sector investment through to 2018 will have a dampening influence, suggesting that the economy will remain relatively subdued.”

The forecasts are at odds with AMP Capital’s Shane Oliver who recently said if the cash rate falls on Melbourne Cup Day, it will likely spell the end of the end of the RBA’s easing bias.   

“You can create financial instability because people will be motivated to take on more debt than they otherwise should have, and there is a risk that at some point they might default on that debt, when interest rates start rising or property prices take a tumble,” Mr Oliver explained, pointing to the dangers of having a continually falling cash rate.

Mr Oliver predicted the RBA would likely cut the cash rate to 1.25 per cent next month, but said it would be a “close call”.

“If you look at growth in Australia it’s actually been quite reasonable,” he noted. “We’ll get to the point where the RBA will conclude that they’ve already done enough to help push inflation back up and push the currency down, so I actually think a cut in November or a cut to 1.25 per cent would probably be it.”

Speaking on a recent episode of The Smart Property Investment Show, Yellow Brick Road’s Mark Bouris agreed that taking the cash rate too low would actually increase Australia’s economic difficulties.

“I think there is some sort of political bias about not reducing the rate any further – because they’ve got to keep head room in there for themselves,” he said on the podcast.

“I think if the cash rate was at 3.5 per cent, they probably would have reduced the rate by another 25 basis points [in October]. I think where it’s at currently, there’s not much head room in case something really goes wrong.

“I think they’re worried if something goes wrong at a point where they really need stimulus in the economy, they’re not going to get it from the government and fiscal policy, that’s for sure. So the only way we can actually stimulate the economy is through the cash rate.”

Mr Bouris noted a lower cash rate can be “counter-intuitive” and can cause panic in the community and lower consumer confidence.

“So my gut feeling is, unless something tragic really happens at the moment, or they foresee something tragic happening, they’re going to leave rates where they are.”

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