Will rates be cut next week?

Until a few weeks ago, it seemed highly likely that the Reserve Bank of Australia would be leaving official interest rates on hold for many months to come, including next Tuesday when it next meets to discuss the economic outlook.

Steady interest rates for the next few months remains the most likely outcome, but with the recent market turmoil, a faltering in global economic conditions and some growing evidence that the housing market is poised to head lower, the door is opening ever so slightly for an interest rate reduction.

The RBA meeting next week will dissect each morsel of information on the economy and financial markets and it will be acknowledging that the risks to its previous rosy outlook are moving squarely to the down side. 

Also read: RBA happy to keep cash rate unchanged
In other words, the RBA forecasts for a pickup in GDP growth into 2016 and with it, an eventual lowering in the unemployment rate, are under pressure.

So what has happened?

Importantly, global economic conditions are undershooting expectations with most forecasters downgrading economic growth forecasts for 2016.

With this, commodity prices remain weak which is undermining Australia’s export earnings and income.

At the same time, the run of news on the domestic economy is mixed with retail spending growth moderate, the housing market poised for a downturn (from a very high base it must be noted) and the business investment climate still bleak.

The change in Prime Minister and Treasurer last month has seen some in the business sector express a hope of a more vibrant and pro-growth policy agenda.

Of course, the proof of this will be in any change in the policy direction from the government on issues such as tax, infrastructure spending and other productivity enhancing measures.

These will take time to come to fruition and is something that the RBA will likely have at the back of its mind as it considers the prospects for the economy in 2016 and beyond.

For now, the RBA will sit tight, feeling that monetary policy is already stimulatory.

Interest rates are at record lows, including for mortgages and business borrowing and this is freeing up cash flows for those with debt and is encouraging a lift in investment as the potential interest costs for new projects are at record lows.

Also read: RBA says confidence is not low

The RBA is also placing great emphasis on the very low level for the Australian dollar, now around US 70 cents, as a means to underpin a stronger economy.

The lower dollar, which is a massive 35 per cent below the 2011 peak, will help support exports and import replacement (for example Australians are more likely to be travelling within Australia and not overseas).

There is already some evidence that the lower dollar is helping to support economic growth with a sharp lift in inbound tourists and foreign students enrolling in Australian universities.

This is the sort of good news that the RBA will be focusing on and is why it will be content to leave interest rates unchanged.

How the balance of good news versus bad news on the economy tilts in the months ahead will help determine whether the next move in official interest rates is up or down.

There are still reasons to be optimistic, but the events of the last few weeks are bringing that rosy view into question.

 

Stephen Koukoulas is a Yahoo7 Finance expert with more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks and as economic advisor to the Prime Minister of Australia.