As the Australian economy continues to plod along the RBA is considering yet another rate cut in the hope of giving consumer spending a push. But will the shock to the heart of lower interest rates be enough, especially given the negative effects on retirees and others reliant on interest-bearing investments to fund their daily lives?
Consumer spending is the main component of economic growth, accounting close to 60% of Australia’s GDP. Governments and the Reserve Bank try to increase spending by various means but the principal tools in their kit are interest rates and tax cuts. We’ve had a few goes at using tax cuts to boost the economy but the most recent round, in July this year, adds only about $100 a month to most people’s take-home pay, not enough to paint the town red. These tax cuts probably only make up for the absence of wage increases which have averaged about 4% historically but have fallen to around half that in recent years.
On top of these tax reductions we’ve also had three interest rate cuts in 2019: 25 basis points in each of June, July and October. The purpose of these is to give consumers more cash to spend by making money cheaper to borrow and by lowering the repayments on floating-rate mortgages. Among other things, it can have additional effects on the economy such as making our exports cheaper if the Australian dollar falls as a result of the lower interest rates.
The monetary theory is sound: give consumers more money to spend and they’ll do just that and, as they do, the money flow multiplies through the economy increasing economic growth, jobs, GDP and smiles across the front bench at parliament house as politicians take the credit for it.
Alas, this time around things are not going to the script. Despite record-low interest rates, tax cuts and good old-fashioned jawboning, the Australian economy refuses to budge. It’s got a wheel stuck in a ditch with 19,000 jobs lost in October 2019 and an unemployment rate of 5.3%. It seems that the government’s tax breaks have failed to move the dial on consumer spending, and the economy is withering on the vine.
And here’s why: Australians have so much borrowed money owing that the household debt-to-income ratio is now around 202%: everyone owes twice their annual salary. That’s up from almost half that figure 20 years ago and is close to the level it was when interest rates were 7.5%. Borrowers understand the precariousness of their situation and are acutely aware that any interest rate rises will bite them hard. A massive debt overhang is driving a frugality which is hurting the economy. Consumer sentiment isn’t strong.
It’s no surprise then that any chance borrowers get to have some additional free cash flow isn’t going into the cash register at Harvey Norman but straight onto their mortgage. Borrowers are trying to run down their debts rather than shop till they drop. The Big Four all report that borrowers are knocking their debts down. The CBA says that less than 7% of its mortgage customers are paying lower repayments since the rate cuts started mid-year; at ANZ 97% of customers are making more than the minimum payment. NAB and Westpac customers are following suit with less than 1% each electing to spend their windfall on non-mortgage related purchases.
The RBA predicts that wages will grow by only 2.2% this year and will stagger to a 2.3% rate by the end of 2021, by which time they’re tipping unemployment could fall to 4.9%.
Household consumption spending is now expected to grow by a feeble 1.4% this year. Retail sales haven’t been this bad since the 1990-91 recession, with demand for furniture, cars, utilities and recreational goods all slipping sharply over the past year.
Faced with a population of closed wallets and with the Christmas period fast approaching the RBA is foreshadowing a further 0.25% rate cut in early 2020 plus the chance of “unconventional monetary policy” despite it being increasingly clear to them that neither of these will be sufficient to achieve their desired outcomes. Call it whatever you like, but the government and the RBA appear to be doing the same thing over and over and expecting a different result.