Economic update

Across a number of countries, monetary policy was eased further with cuts to interest rates. Fiscal policy (taxation and spending) also featured in public debate (Germany) and was implemented in certain cases (India). The US and the EU reduced interest rates in an attempt to boost economic growth. The rate of economic growth slowed slightly in China, the US and Europe.

The Markit Global Manufacturing Purchasing Managers Index (PMI), which provides a forward-looking measure of global manufacturing activity, remained in contractionary territory.

Similar surveys in the US and China remained positive and improved slightly compared to last quarter. The European economic outlook continued to weaken, which was led by the poor performance of Germany.

Weakness in the EU’s services sector prompted a restart of the European Central Bank’s asset purchasing program, also known as ‘quantitative easing’, which aims to increase the money supply and encourage lending and investment.

Australia

In Australia, economic data was disappointing. Economic growth in the June 2019 quarter was 0.5%, which, while in line with expectations, resulted in economic growth of only 1.4% for the 12-month period. This is a decline from the 3.1% growth rate reported in the 2017/18 financial year.

The annual inflation rate was 1.6% for the year-ended 30 June 2019. This is below the Reserve Bank of Australia’s (RBA) target of between 2% and 3%.

Both the NAB Monthly Business Survey and the Westpac Melbourne Institute Index of Consumer Sentiment pointed to subdued confidence among businesses and consumers. This has occurred despite the anticipated stimulus driven by the RBA’s sequence of interest rate cuts and the Government’s tax offsets for lower income earners. The Government may need to do more to reinvigorate economic growth.

The relatively weak economic data may see the RBA make further reductions to interest rates before the end of the year.

Fixed income and currencies

Interest rate cuts contributed to the positive performance of bonds during the quarter. As interest rates fall, bond prices typically appreciate because they offer a higher yield than the cash rate. This enhances short-term returns and increases potential capital gains.

However, this comes at the cost of lower future returns. The Australian 10-year Government Bond is now offering a yield of only approximately 1%. This suggests the possibility of investors receiving lower long-term returns from bond portfolios.

The Australian dollar fell as a result of weaker global growth, RBA interest rate cuts and weaker iron ore prices following increased production in Brazil by Vale, a major iron ore producer.

The impact of the Reserve Bank of Australia’s rate cuts

This year the RBA cut rates by 0.25% in June, July and October. This was for several reasons. The RBA was responding to a weaker global economy and was concerned about how this would impact the Australian economy. It also hoped that by cutting interest rates it would lower unemployment without increasing inflation substantially.

And a third reason was to stop the Australian dollar rising too much, which would impact our exporting businesses against countries such as New Zealand which had already cut interest rates substantially.

RBA rate cuts have different impacts across the economy. Some groups and areas benefit while others are disadvantaged. These include:

• Borrowers: The majority of bank lending is for housing. Lower interest rates, provided they are passed on by banks to borrowers, reduce mortgage repayments and improve borrower spending capacity. The hope is for increased consumer spending to support economic growth.

• Savers: Savers are penalised by lower interest rates because they receive less interest This disadvantages retirees and people with large amounts of cash held in bank accounts or conservative investment portfolios.
• Property market: Lower interest rates increase potential borrowing power and help to increase property prices. They also make property, with its potential for higher returns, more attractive than other safer investments such as cash. As a result, following the rate cuts, we have seen price rises in the Sydney and Melbourne property markets.
• Consumer spending and sentiment: If consumers feel confident about their future prospects, rate cuts can help encourage further spending. Or, interest rate cuts can have the opposite impact where too many cuts make consumers feel concerned about economic growth. Recently this has occurred with consumer sentiment falling to below-average levels after the three rate cuts.
• Business investment: Rate cuts make it easier for businesses to borrow at lower rates of interest or to issue bonds with lower yields. While this can encourage business spending this is typically only true if businesses are already struggling from a high cost of capital. If that is not the case then any impact on business investment is likely to be minimal.
• Economic growth: To grow the economy, rate cuts can be seen as a supply-side solution by making borrowing easier. If access to credit is not a major issue for consumers or businesses then the impact is limited. This may mean the Government needs to implement demand-side solutions, such as investing in transport and other infrastructure, that directly encourage more spending within the economy.

Source: IOOF