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Bushfires boosting the chances of another interest rate cut

Tourists watch the bush-fire from the safety of the Echo Point Lookout. Australia's tourism sector is expected to take a hit from the bushfires. (Source: Getty)

The Australian bushfires have so far razed more than seven million hectares of land, killed more than 25 people, destroyed more than 1,800 homes and wiped out more than a billion wildlife animals – and the fall-out will be emotional, traumatic as well as economic.

Experts are already estimating that the fires will result in a 0.4 per cent hit in GDP, but the tourism, farming, manufacturing and business sectors will also be badly hamstrung. In some local communities, the economic activity is said to be at zero.

And this may force the Reserve Bank of Australia to cut the nation’s already record-low rates even further when the board convenes for the first time this year.

UBS economists have stated it was still too early to know the full impact of the bushfires, but that the crisis would be a drag on GDP growth in the short term.

Consumers are likely to hold back on their spending in the coming months due to higher food prices – from the drought and bushfires – and rising insurance premiums.

“Overall, we think this makes a rate cut from the RBA in February more likely,” wrote UBS economists George Tharenou and Carlos Cacho.

They pointed to the RBA’s December minutes, in which they said they would “reassess the economic outlook in February 2020” and could “provide further stimulus to the economy, if required”.

AMP Capital chief economist Shane Oliver agreed, adding that consumer sentiment was already low to begin with – and has been further hit by the constant news of the fires and the smoke haze.

“Australians feel less motivated to spend when their fellow Australians are suffering,” Oliver said.

The hit to consumer spending from the bushfires will add to the pressure for greater policy stimulus, and Oliver also believes that the RBA will cut the cash rate to 0.5 per cent next month – and again in March.

Independent economist Stephen Koukoulas told Yahoo Finance the RBA should cut rates – but not because of the fires, but because of inflation, the jobs market, and the economy more generally.

Will cutting interest rates work? What else can we do to boost the economy?

Lowering the national cash rate isn’t the only tool we have up our sleeves. According to Oliver, Australia needs more than monetary policy – and this is where the government could choose to step in.

“There is a need for a broader fiscal stimulus – maybe in the form of a bring forward of the personal tax cuts, an increase in Newstart and broad based investment allowances,” he said.

“To have an impact it needs to be at least 0.5 per cent of GDP (or around $10 billion).”

Jim Stanford, the chief economist for the Australia Institute’s Centre for Future Work, said there were doubts about the efficacy of the RBA’s rate cuts.

“The real question is what else will be done – because other than re-igniting a bubble in property prices, it isn’t clear the RBA rate cuts are having any positive impact on the real economy at all,” he told Yahoo Finance.

“In a context of weak business investment, stagnant wages, and consumer pessimism, lower interest rates are like pushing on a string.”

He echoed Oliver’s sentiments that more fiscal stimulus was needed.

“Some of that will come from spending on the fires themselves, and eventual payments for rebuilding (financed partly by government, partly by insurance companies, and partly by fire-affected households themselves). But rebuilding will take time,” said Stanford.

According to him, the federal government could provide:

  • Immediate compensation payments to fire victims and firefighters;

  • Immediate commitments to infrastructure repairs and rebuilding;

  • Fiscal easing in other areas – such as removing the arbitrary 2 per cent wage cap on all federal public servants.

Which sectors have been hit hardest by the bushfires?

The agriculture, tourism, retail and construction sectors are likely to be hardest hit, with UBS figures estimating the damage to be at 2 per cent, 3 per cent, 4 per cent and 7 per cent of GDP respectively.

Inbound tourism will also languish for about a year, Oliver added.

Is it all bad news?

Oliver and Koukoulas both noted that while the period following a natural disaster causes disruption in economic activity, the rebuild after that actually sees a boost in wealth.

“In this sense measured across a year or so they are often seen as positive for economic growth, albeit this seems perverse particularly for those directly impacted,” Oliver said.

Koukoulas said the rebuilding of homes, commercial and rural buildings, and infrastructure would be a stimulus to the economy from mid-2020.

“Economists should be adjusting the quarterly profile for GDP by trimming a few tenths off Q4 2019 and Q1 2020 but adding a tenth or two each quarter for the following 18 months - and if it rains, farm output will add a further 0.25 per cent to GDP,” Koukoulas said.

“So it looks like by late 2020 and early 2021, GDP could easily be above 3 per cent, assisted by the changing growth patterns and rebuild as a result of the fires.”

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