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Economy may have reached gentle turning point
Reserve Bank Governor Testimony

Reserve Bank Governor Testimony: Reserve Bank Governor Philip Lowe has appeared before the House of Representatives Standing Committee on Economics.

Testimony by the Reserve Bank Governor can have a major impact on interest rate expectations.

What does it all mean?

• The Reserve Bank Governor last testified on the economy in February. At that time we noted: “It is all about jobs, home prices and China. If the Reserve Bank was to cut rates it will probably take an extended China-US trade war, a fall in consumer spending due to lower home prices and a weaker job market. It is always important to remember that the Reserve Bank is forward-looking. It will have to perceive that these events are likely, prompting the need for lower interest rates.” Clearly the Governor’s testimony can be pivotal in affecting expectations. So what is the Governor saying this time?

• The Governor believes the economy is on the right track. He is by no means super optimistic, rather cautiously optimistic, saying that the economy “may have reached a gentle turning point.”

• One key point the Governor makes is that an unexpected lift in labour supply (rise in workforce participation and strong job growth) has meant that the unemployment rate has been higher than expected. That has meant that wage growth has been lower together with inflation, leading to lower interest rates.
Prepared comments

• The prepared remarks by the Reserve Bank Governor can be found here.

https://www.rba.gov.au/speeches/2019/sp-gov-2019-08-09.html

• Economy: “There are signs the economy may have reached a gentle turning point.”

• Economic growth: “Our central forecast is for the Australian economy to expand by 2½ per cent this year and 2¾ per cent over 2020. The growth forecast for this year has been revised down since we met six months ago, but the forecast for next year is unchanged.”

• Inflation: “Looking ahead, inflation is still expected to pick up, but the date at which it is expected to be back at 2 per cent has been pushed out again. Over 2020, inflation is forecast to be a little under 2 per cent and over 2021 it is expected to be a little above 2 per cent.

• Monetary policy: “In the central scenario that I have sketched today, inflation will be below the target band for some time to come and the unemployment rate will remain above the level we estimate to be consistent with full employment. While this remains the case, the possibility of lower interest rates will remain on the table. The Board is prepared to ease monetary policy further if there is additional accumulation of evidence that this is needed to achieve our goals of full employment and inflation consistent with the target. Time will tell.”

• Stimulus: “…for every dollar the household sector receives in interest income, it pays well over two dollars in interest to the banks and other lenders. This means that lower interest rates put more money into the hands of the household sector and, at some point, this extra money gets spent and this helps the overall economy.”

• Job market: …”a higher share of the Australian adult population is participating in the labour market than ever before. This is good news. But one side-effect of this flexibility of labour supply is that it is harder to generate a tight labour market and so, in turn, it is harder to generate a material lift in aggregate wages growth.”

• Job market: “Looking forward, while some slowing in employment growth is expected, the central scenario is for the unemployment rate to move lower to reach 5 per cent again in 2021. If things evolve in line with this central scenario, it is probable that we will still have spare capacity in the labour market for a while yet, especially taking into account underemployment. This means that the upward pressure on wages growth over the next couple of years is likely to be only quite modest, and less than we were earlier expecting.”
Questions & answers

• The Governor noted a global structural change where there is greater desire to save and reduced desire to invest. “Investment intentions are weak”. The Governor noted that the US-China trade war is one of the factors causing a reluctance to invest.

• Governor rejects view that lower interest rates have damaged consumer confidence.

• Governor and Dr Lucy Ellis (Assistant Governor, Economics) responded to question about whether interest rates cuts are still stimulatory. Governor indicated he understands the impact of rate cuts on those who have significant savings through bank deposits. Dr Lucy Ellis notes a slowdown in the growth of bank deposits over the past five years.

• Dr Lucy Ellis notes the rise in the workforce participation rate at a time when demographic factors would suggest a fall in participation.

• The Governor said that the election had a zero impact on Board decisions. Governor notes some uncertainty at the margin about housing in the lead up to the election.

• The Governor said the RBA won’t be increasing rates until it is confident that inflation was heading back into the target band.

• The Governor rejects the view that the Reserve Bank has somehow failed over the past three years in achieving the 2-3 per cent rate target. It will take some time to make an assessment.

• Because of labour force flexibility (strong growth in labour supply) the jobless rate could have been lower while wage and price growth may have been higher.

• Governor says that RBA is prepared to do unconventional things on monetary policy should they be required: that is, interest rates near zero.

• The Governor has tried to be as clear as possible that low interest rates will be with us for some time.

• Governor notes that ‘forward guidance’ is another form of ‘transparency’. Governor rejects strongly the inference that the Reserve Bank is one of the less transparent central banks in the world.

• The Reserve Bank Governor says that the country needs to do everything in its power to lift productivity as that is essential in lifting living standards.

• Governor is hearing a lot of reports from employers that they are finding it hard to find people with the appropriate skills.

• Tax offset payments expected to boost household disposable incomes by 0.6-0.7 percentage points with around half of the payments to be spent.

What are the implications for interest rates and investors?

• The Reserve Bank Governor believes the economy is on the right path and that growth will pick up over 2020.

• Unfortunately political grand-standing and point-scoring has prevented some useful important issues to be discussed in the meeting of the House of Representatives Standing Committee on Economics.

• CommSec expects the Reserve Bank to assess the impact of previous rate cuts before deciding further moves on cash rates.

Published by Craig James, Chief Economist, CommSec