An Older, Slower Australia Leaves RBA in No Rush to Stimulate

Updated on

When you get older, work less efficiently and have fewer new arrivals, sometimes it’s best to accept it. That could be the Australian central bank’s conclusion as it considers how hard to push the economy.

Similar to the U.S., debate is intensifying Down Under on whether potential growth is lower than earlier thought, which would help explain a stabilizing labor market. A reduced speed limit from the RBA would ease pressure to cut interest rates already sitting at a record-low 2 percent. Traders and most economists predict no change at Tuesday’s board meeting.

Having failed to expand faster than 3 percent for six of the past seven years, RBA Governor Glenn Stevens last month raised the prospect of whether the economy may be more suited to growth of less than 3 percent. The central bank updates quarterly forecasts Friday and could downgrade expectations for inflation and economic activity over its three-year horizon.

“The grim reality is that the Australian economy has not expanded at around the 3.25 percent market in a sustained fashion since 2008,” said Michael Blythe, chief economist at Commonwealth Bank of Australia, the nation’s biggest lender. “Lower potential growth means less need for additional policy stimulus and higher risks in overstimulating the economy.”

Keeping a lid on economic expansion is Australia’s slowing population growth, which in 2015 is likely to be the weakest in nine years as potential immigrants look elsewhere. At the same time, the country’s productivity growth has slowed over the last decade as rising incomes from commodity exports meant innovation took a back seat, according to Blythe.

Rating Risk

A lower potential growth rate -- or the speed at which the economy can grow without stoking inflation -- also means the government will struggle to restore its budget to surplus, which it may need to do to hang on to its AAA sovereign rating.

“We could lower the ratings if Australia’s budgetary performance does not improve broadly as we currently expect,” Standard & Poor’s said July 24. “Continued parliamentary gridlock on the budget could trigger this scenario, as could an external shock. The latter could come from further deterioration in Australia’s terms of trade, for example.”

The nation’s terms of trade, or export prices relative to import prices, have fallen about 30 percent since late 2011 as an increase in commodity supply intersected with a slowdown in China.

An official Chinese factory gauge slipped to a five-month low in July, signaling that months of easier monetary policy have yet to kick in and putting pressure on the country’s leadership to take further action.

Yields Fall

The positive is that the currency has dropped almost 35 percent in four years, improving the competitiveness of Australian businesses vying for market share with imports. That could accelerate as the probability of the Federal Reserve raising interest rates in September climbed to 50 percent. A higher U.S. rate would narrow the differential with Australia.

Australia’s record-low rates are fueling a surge in property prices in the country’s biggest cities, rattling regulators. Sydney housing jumped 18.4 percent last month from a year earlier, the biggest increase since December 2002.

Australia’s 10-year bond yield dropped 25 basis points in July, the steepest decline since January, while the premium over Treasuries shrank by the most since February.

The jobless rate has steadied at around 6 percent in recent months, which also limits pressure on the RBA to add stimulus, while surging house prices in Sydney and parts of Melbourne leave the central bank disinclined to cut rates further.

A lower potential growth rate, “could explain at least a big part of the recent labor-market puzzle, where the unemployment rate has remained stable over the past six months, or even edged lower, despite the slowdown in economic growth,” said Paul Dales, chief Australia and New Zealand economist at Capital Economics.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE