Monthly economic e-news – September 2019
17 September 2019
By Craig Turnbull
Chief Investment Officer.
How low will interest rates go?
As fears grow about the health of the global economy, interest rates across the world are sinking to historic lows, and in some cases, even falling into negative territory.
In September, the Reserve Bank of Australia (RBA) left the official cash rate on hold at 1.0% but many analysts are predicting at least one or even two more rate cuts over the next six to twelve months.
What has been the experience of very low interest rates in Europe?
In the wake of the global financial crisis, the European Central Bank (ECB) significantly reduced their main referencing rate. The bank ultimately cut the rate to zero in 2016 and it has stayed there ever since.
These persistently low rates have led to some peculiar outcomes.
This year, the German government issued a 30-year bond offering investors zero interest on their investment and many large investors look up the offer. Essentially, it means waiting 30 years just to receive your original investment back.
Danish bank, Jyske, recently launched the world’s first negative interest rate mortgage, effectively paying borrowers 0.5% to borrow money for ten years.
However, there is little evidence that cheap money is boosting confidence and stimulating demand. Many Europeans, pessimistic about the outlook, are still choosing to save their money despite receiving little or no interest on their bank balances.
In response, the ECB announced at its September meeting that it will cut the bank’s deposit rate to -0.5% and restart their quantitative easing programme. In November, the ECB will begin purchasing €20 billion of bonds and securities each month to increase the money supply and stimulate the economy.
So what is the situation closer to home?
The official cash rate in Australia fell from 4.75% in 2011 to just 1.5% by September 2016 and then flat lined for almost three years. In response to declining growth rates, the RBA has cut rates twice this year to an historic low of just 1.0%.
But despite the interest rate cuts, together with the recent income tax cuts, there is little to suggest that these measures are spurring on spending with seasonally adjusted retail trade figures actually going backwards in July.
Confidence continues to wane with the Westpac-Melbourne Institute index of consumer sentiment falling 1.7% in September. Results from the survey suggest that many people are actually savings the tax cuts, and taking advantage of the rate cuts to pay off their mortgage faster.
One positive outcome from the rate cuts has been the rebound in property prices in some of our major cities. According to CoreLogic, values for all dwellings rose by 1.57% and 1.40% in August for Sydney and Melbourne respectively.
Nevertheless, our annual GDP growth rate stalled at just 1.4% in June. This is very disappointing considering the fact that the rate is being propped up by government spending particularly in disability, health and aged care.
However, despite much evidence to the contrary, the Federal Government appears to be pinning its hopes on the cuts to interest rates and income tax flowing through and eventually stimulating more demand in the economy.
So what can be done?
The experience in Europe seems to support what many economists in Australia have been saying for some time.
Rate cuts will not be enough to convince Australians to go out and spend. In the absence of any meaningful wage growth, many people are more likely to use the extra money to pay down debt or add to their savings.
The case is certainly building for the Federal Government and the RBA to look past tax and rate cuts and start considering some more unconventional measures to stimulate our economy.
Markets at a glance
for the month ending 31 August 2019
Australian shares1 down by 2.36%
Australian Government Bonds yield2 down to 0.885%
Australian dollar down to US$0.6718
Cash rate3 steady to 1.00%
International shares4 down by 2.17%
1 ASX 200 Accumulation Index
2 Yield on 10 year Australian Government Bonds
3 RBA cash rate
4 MSCI – World ex Australia (USD)