The Reserve Bank of Australia delivered back to back interest rate cuts this month with the cash rate lowered a further 25 basis points to 1%. This followed the 25 basis points cut last month. With inflation currently running at 1.3% we have now officially entered a period of negative real returns on cash and close to zero returns on government bonds.
The narrative from the Reserve Bank remained similar to last month with some minor adjustments. Despite slower economic and trade growth the outlook for the global economy remains reasonable. Across most advanced economies unemployment rates and inflation are low and there are positive signs on the wages front. Reasonable was also the term applied to the Australian economy with growth forecast to increase from slightly below trend in the March quarter to around trend for the June quarter based on forward indicators.
The underlying message has been the decision to ease monetary policy and lower rates is not being driven by major economic concerns and particularly any near term recession concerns but rather as a mechanism to address spare capacity in the economy with the intention of reducing unemployment further to around 4.5% (5.2% currently) and pushing inflation up into its targeted range of 2-3%.
Our view is further cuts from already historically low levels are unlikely to have a significant impact on the economy. The election has given the conservative government a clear mandate and, in our view, the best way to kick start wages and inflation is to put serious economic reform back on the table in areas such as taxation and industrial relations. What we need are policies that will drive productivity growth as this and only this is the main driver of wages growth and living standards over the long term. Similarly, further easing of monetary policy is not without its risks and could lead to further asset price distortions. It also leaves the governments with very little monetary policy fire power should a recession occur.
Other major economies appear to be treading water. In the Eurozone negative growth contributors including slowing exports and investment are being offset by decade low unemployment and spending on services. The net result is for economic growth for the Eurozone to remain tepid at best at about 1.2% for 2019. The Japanese economy is forecast to growth by less than 1% for 2019.
The US is faring much better in absolute growth terms but with similar macro trends. Very strong employment and in turn domestic consumption expenditure is offsetting the slowdown in exports and investment. Indeed at 121 months from June 2009, the US is now into its longest period of economic expansion in well over a century. The US Federal reserve left rates on hold in June but noted that growth is slowing, and monetary policy would be used to support the ongoing expansion of the US economy if required. A re escalation in trade tensions post the positive outcomes at the G20 talks in Japan on the 28-29th of June appears to be the biggest risk to global growth in the short term.
In relative terms the Australian economy appears to be in reasonable shape. Perversely, the stimulatory response to the trade war induced slowdown in China is likely to see further strength in mining and energy commodity prices and volumes and in turn a rebound in mining investment. As mentioned last month the composition of economic growth in Australia stands in sharp contrast to the US and Europe. As noted previously in the Eurozone and the USA the slowdown in investment, industrial production and exports is being offset by consumer spending. In Australia investment and very strong export growth is offsetting a weak consumer.
China’s economy is forecast to slow to 6.2 % for 2019 down from 6.6% in 2018 largely on the back of weaker industrial production and exports due to the trade wars and imposition of tariffs on imports into the USA. As in the past China has stated it will stimulate the economy as required to keep economic growth within its current targeted range of 6%-6.5%. As the world’s second largest economy China will nevertheless continue to be the largest contributor to global economic growth in 2019.
cash and bonds now delivering negative to zero real returns it is no surprise that
equity markets are pushing higher. The Australian ASX 200 has pushed through
its pre GFC peak to an eleven and a half year high this month and in the USA
all the major indexes are trading at record highs. That said, the race to the
bottom on interest rates reflects slowing global economic and trade growth. While markets and the economy are not always
correlated risks to earnings growth globally and investment returns in FY
2019/20 appear skewed to the downside. The
latest data out of the US shows a significant jump in the number of companies
issuing negative earnings guidance for the June quarter. To date it appears the
trade war is having its greatest impact on globally exposed companies in sectors
such as Information Technology equipment, health care equipment and software
and services. A combination of Brexit in
Europe and ongoing negotiations between China and USA appears unlikely to see
any significant turnaround in world trade growth any time soon.
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Sources: Commbank Global Markets Research, RBA, Morningstar.