Australia | Dec 09 2008
By Chris Shaw
Having previously expected Australian interest rates would bottom out at 3.5% in March of next year, Westpac chief economist Bill Evans now sees this as too conservative a scenario given the poor state of the domestic and global economies.
With the world in deep recession, Evans expects the Reserve Bank of Australia (RBA) will extend its stimulatory policies into the June quarter of next year, which implies interest rates falling to a low of 2.75%. Rates are unlikely to stay at this level for too long though, as Evans sees increases in official interest rates starting early in 2010. This should take the official cash rate back to 5.0% by the end of that year.
His reasoning is the RBA will be careful not to fall into the same trap as former US Federal Reserve chairman Alan Greenspan, who was criticised not for lowering US interest rates as far as he did in the wake of the economic downturn post the dotcom crash, but for keeping rates too low for too long.
As Evans notes, the three percent cut in rates in the past few months has been the RBA’s most aggressive three-month cycle of activity since interest rate targets began in 1990. The moves represent the RBA’s attempt to get ahead of the curve to stave off any collapse in domestic demand.
And this time monetary policy action is being matched by fiscal policy action from the Federal Government, though whether or not the coordinated response is successful remains too early to determine. To date the results are not great, as Evans notes consumer spending in the September quarter rose just 0.1% despite the boosts from policy.
But as Evans points out, the December quarter will provide a greater boost to households given the stimulus package takes effect and the recent cuts to interest rates will have had time to flow through. The unknown is if households act in a similar manner to the September quarter and put most of the money into savings rather than spending it. If they opt for the latter this will boost the savings ratio to almost 12%. This would be its highest level since 1984.
While such an outcome is unlikely, Evans does see the savings ratio rising to around 7.5% from around 3.9% in the September quarter, which implies enough being spent to keep GDP growth at positive though weak levels.
Assuming such an outcome, Evans expects the RBA and the Government would see the need for further stimulus early in both the March and June quarters next year. This implies not only an extension of the timetable for interest rate policy easing, but also an acceptance of the need for a budget deficit to help boost the economy and to avoid recession.