Economic Outlook - June 2016

The Reserve Bank of Australia (RBA) cut the cash rate by 0.25% to 1.75% at its May board meeting. The bank made the move in response to low inflation figures, while also indicating a lower Australian dollar, the result of a reduction to the cash rate, would assist the economy as it makes exports more competitive. Expect at least one more cut to the cash rate in 2016.

Mixed economic data is one of the reasons for the RBA’s cut. A positive sign is improving employment figures, with the unemployment rate falling to 5.8% in May from a peak of 6.3% in July last year. Conversely, consumer confidence has been lacklustre, partly reflecting relatively low wages growth. But after the May interest rate cut confidence improved sharply and is now the strongest it has been since January 2014.

Conditions in international markets are mixed. Chinese economic data is continuing its slow downward trajectory. The latest figures indicate GDP growth has slowed to 6.7%, from 7% a year ago.

This trend is expected to continue, which is the normal path of a developing economy. It’s worth noting China is successfully transitioning its economy and the services sector now makes up more than 50% of the market. This is in contrast to industrial production, which makes up around 40% of the economy.

In the developed world, central banks are following different paths, which reflect their different perspective of the economic outlook and conditions in their markets. The US Federal Reserve lifted its official interest rate in December 2015 and there were expectations it would continue this trend in 2016. But rate hike expectations have now been wound back, although at least one more rate cut is anticipated this year. Improving employment data, positive consumer sentiment and early signs wages and consumer prices are growing also indicate a more sustained economic improvement in the US.

In contrast, the European Central Bank has kept its official interest rates at extremely low levels. Its decision to continue expanded monetary policy measures is likely to limit deflation and help protect the economy from entrenched downside risks.

Fears of deflation saw the Bank of Japan introduce negative deposit rates early this year with a recent warning rates could move further into negative territory. Negative deposit rates mean commercial banks are, in effect, required to pay a fee rather than receive interest for depositing excess funds with the central bank. This is designed to encourage banks to increase lending instead of leaving excess reserves lying idle.