Australia | Jun 08 2016
– Oz retail sales strong, currently
– House prices and rate cuts supportive
– Income growth negligible
– Housing boom temporary
By Greg Peel
What is a “normal” interest rate?
Effectively it is the level of cash rate a central bank can set that ensures an economy is neither overheating nor receding, but rather ticking along nicely at a “normal” pace. Which brings us to the next question: Are interest rate cuts always a good thing for markets, and hikes always bad?
If we consider the rally in the ASX200 which has occurred since the RBA’s surprise rate cut in May, and assumptions of further cuts to come, we would have to conclude yes: rate cut good, rate hike bad. But to take such a simplistic approach is to ignore the reason behind any change in policy, which is where “normal” comes in.
One of the sectors to enjoy the benefits of the May rate cut is retailers. The thesis is simple: Rate cuts mean lower mortgage payments means more money in punters’ pockets to spend, and lower rates mean higher house prices mean greater perceived household wealth means greater incentive to spend.
Consumer confidence duly rose following the May rate cut. But did anyone stop to think just why the RBA was forced to cut?
While Australian retail sales growth slowed in early 2016 to an annual pace of 3.6% over the year to April, for some time now retail sales growth has outpaced lacklustre underlying income growth, notes Deloitte Access Economics. Sales growth has instead been driven by rate cuts and rising housing wealth.
The Australian economy has to date offered strong resilience in the face of falling commodity prices and rapidly declining mining investment, but quite a toll has nevertheless been taken on national income growth. It is against this backdrop that the RBA announced its May rate cut. “Many of the challenges to the Australian economy to which the Reserve Bank is responding,” notes Deloitte, “are also challenges for retail”.
A rate cut might be seen as a form of stimulus, but if an economy needs such stimulus clearly there is something wrong with the economy. If a central bank raises its cash rate to levels above normal, it is to put the brakes on an economy growing too fast. If it works the central bank can then cut its rate again in order to prevent the economy slowing down too fast, but any rate above normal suggests a positive economic environment.
If a central bank raises its cash rate when rates are below normal, as in the Fed last December, the negative of a rate hike is outweighed by the positive implication of a recovering economy. If the cash rate is cut when already below normal, this implies a safety net but confirms the economy is in trouble.
If a central bank cuts its cash rate from historically low to historically lower, the economy is in quite a lot of trouble. Is this the appropriate time for consumers to rush out and update their wardrobes?
Deloitte notes the current 3.6% retail sales growth rate is being driven by non-food retailing, with clothing retailers and department stores the stand-out sectors in early 2016. Retail sales growth has been able to outstrip growth in income largely due to the willingness of consumers to run down their savings, Deloitte points out, assisted by a house price boom which provided a big boost to the housing wealth of many consumers. In addition, a boom in housing construction has encouraged spending on consumer durables, while a fall in petrol prices had diverted some income from petrol retailers to other retailers.
The difficulty now facing retailers is that many of these supports are temporary, Deloitte warns.
Many an analyst is assuming the Australian housing boom will soon slow. Further RBA rate cuts, if they are forthcoming, would prolong the boom but not prevent the inevitable. Already there are grave fears for an overheated apartment construction frenzy. When supply finally outstrips demand, prices will fall and construction will cease in their wake.
Oil prices have already rebounded considerably.
All the while the challenges to income growth are continuing, with wage growth remaining at record lows.
Real (adjusted for inflation) retail sales growth was 3.3% in 2014-15, Deloitte notes. Following that strong outcome, Deloitte’s analysts see growth slowing to 2.5% in 2015-16 and 1.9% in 2016-17.
At present, retail sales growth is balanced between outperformance in the non-mining states, particularly NSW and Victoria, and underperformance in the mining states, particularly Queensland and Western Australia. “But the likelihood is that housing markets will be less of a positive for retail going forward,” Deloitte warns, “meaning that retail sales growth may slow elsewhere through the year ahead, particularly in NSW and Victoria”.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
