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Australia: expect further rate cuts and a lower dollar

Date: Apr 08th, 2015

By AMP Capital Markets

At the same time, Australia’s national income has taken a hit as the demand for our main exports – particularly iron ore and coal – have fallen. This has been augmented by a collapse in energy prices. All of these things are weighing on the economy.

Australia’s central bank has done its part to stimulate growth

The Reserve Bank of Australia (RBA) has been attuned to the issues of growth in Australia; that the economy needed help, we needed to get the non-mining part of the economy going again like housing, tourism, retailing and so on. It’s done its part by cutting interest rates, which has led to a pick-up in the housing sector and stronger flows into retailing. As such, we have not gone into recession, as some predicted would happen, but the economy is still lagging. The Australian economy is currently growing at a pace of around 2-2.5% which is well below its long-term potential. In turn, this means unemployment is slowly drifting higher. In response, the RBA has indicated that it has an easing bias. In other words, its inclination is to cut interest rates a little further and we will probably see that in the months ahead.

How do rate cuts boost the economy?

Those with a mortgage should get a boost, those who have bank deposits loose out. But just bear in mind that Australians owe the bank far more than the banks owe them. That’s why, when you cut interest rates, the benefit to those with a mortgage actually swaps the loss of an income to those with fixed deposits or bank deposits.

Expect a lower Australian dollar

One of the issues through to last year was the fact that the Australian dollar held up at a level which was too high; hovering around the mid-90s for a long while. Now, of course, that’s come down and there’s probably more downside ahead. We believe that the Australian dollar remains overvalued and whilst there may be some short-term bounces along the way, the dollar is likely to head towards $US0.70 and possibly lower in the period ahead.

A case for getting the budget under control

As we head into May’s Federal Budget, we’re likely to see a bit of a re-run of what we saw last year. That is, the government may try to make the case that we need to cut back on government spending. Last year, we had the audit of government to pave the way for budget cuts. Of course, this year we’ve had the 'Intergenerational Report', which has again highlighted the pressures on government spending in Australia, particularly from the ageing population with areas like health, pensions and other welfare going forward. Overall, we’re likely to hear more talk about the need to get the budget under control – but probably in a bit more of a controlled fashion than what we saw in the budget last year.

Final thoughts

As interest rate cuts continue to feed through the economy, it would help if there was a bit more confidence coming out of Canberra. The constant political uncertainty may be weighing down, particularly on business confidence. Therefore, it’s understandable why the economy is going through a slower patch. Just bear in mind, it’s not collapsing, but it still needs some stimulus. Ultimately, we believe that the Australian economy is likely to pick up as we go through into 2016.

In this video, Dr Shane Oliver, AMP Capital’s Head of Investment Strategy and Chief Economist, discusses why the Australian economy is slowing and how the central bank is responding. He also highlights what investors can expect in the lead-up to May’s Federal Budget.

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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