The outlook for global and Australian interest rates

The path of global interest rates is a favourite news headlines of late. Media have pounced on commentary by ex-Reserve Bank of Australia (RBA) Director John Edwards who said: “IF [my emphasis] the RBA’s economic forecasts prove correct...” we could see some eight moves up in the RBA’s cash rate. Simultaneously, there seems to be a coordinated round of central banks making ‘hawkish’ statements (meaning interest rates could go up). This included the US Federal Reserve’s (Fed’s) actual 25-basis-point increase, and the Reserve Bank of Canada, the Bank of England and the European Central Bank all implying their next movement would also be up.

Interestingly, these comments followed publication of the Bank of International Settlement’s (the central banks’ ‘central bank’) Annual Report. It warned global financial stability is at risk if rates aren’t raised when needed because central banks are too focused on weak growth in wages and prices. Their main concern is that debt continues to pile up and financial market risk taking is gathering steam – both fed by loose monetary policy.

It’s worth giving some context to all this furore about the raising of rates

Back in 2014, the US Fed predicted that at the end of 2017, its cash rate would be 3.75 per cent. Current market expectations are, at best, 50:50 that it will be 1.5 per cent; while just two months ago, the Bank of England’s Mark Carney pointed out that “now was not the time” to be raising rates given weak wages and low inflation. Global benchmark bond yields are also effectively unchanged to slightly lower over the calendar year to date – suggesting the bond market broadly does not believe all the talk.

A closely watched predictor of the health of the US economy lies in the difference between 2-and-10-year Treasury Bond rates. Generally, the 10-year rate is higher as the market predicts that rates will go higher in future when the economy is growing and inflation is rising. That differential has nearly reached its lowest level in the last decade, meaning the bond market is not confident about the path for the US. That the two rates have not reversed their normal position (i.e. the yield curve has not inverted) is grounds for remaining positive, but the differential should be watched.

There are important indicators to watch when considering Australia’s path too

Delving further into John Edwards’ commentary, he qualified his prediction by saying, “if household spending weakens... if the Australian dollar strengthens...” the path to higher rates would be slower.

Important indicators to benchmark the health of our economy are things that affect the consumer, and in a positive sign, retail spending for May was higher than predicted. However, we see four key headwinds for Australian households:

  1. soft wage growth (the lowest on record)
  2. high household debt (conversely the highest on record)
  3. slower house price growth
  4. rising mortgage rates (despite the RBA’s cash rate remaining unchanged).

Some commentators note high household debt is balanced by growth in household assets (notably superannuation and the value of the family home) and see this as a reason to remain sanguine about the high level of debt. In a balance-sheet sense, this is true enough, however, those assets are generally locked up, meaning cash-flow problems if mortgage or credit card debt payments rise. Cash-constrained households do not tend to spend.

Overall, we remain cautious and expect policy interest rates to remain on hold

There are positive signs of growth in global economies with those effects evident for example, in the emerging markets and Europe. While ultra-low interest rates have encouraged poor behaviour in terms of risk taking and debt proliferation, the fact remains that lower unemployment and nascent global growth is not yet translating into wage growth at the level of the ordinary consumer. We will be much happier when it does. In the meantime, we expect policy interest rates to remain on hold in Australia and to move more slowly than recent commentary has suggested elsewhere in the world.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Patrick Broughton

Investment Committee Member

Patrick has 32 years of investment banking experience spanning over a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange.

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