Government spending bonanza gives RBA breathing room on rates

Australia's economy is set for a fiscal injection as the Coalition government, trailing in opinion polls ahead of the election in May, tries to buy its way back into contention.

The expected spending bonanza in the April 2 budget will be well received by the nation's heavily indebted households. It may also win favour in a more unlikely quarter: the traditionally buttoned-down, inflation-fighting Reserve Bank, which is keen to avoid resuming interest-rate cuts.

With the worst housing slump in decades, RBA governor Philip Lowe is under pressure to cut rates. Credit:AAP

RBA Governor Philip Lowe is under intensifying pressure to end a 2-1/2 year pause in rate cuts as tumbling house prices spook households and slow economic growth.

But with rates already at a record low, the impact of further easing might prove limited. In contrast, well-directed tax cuts and cash disbursements could be just the stimulus the economy requires.

"Fiscal easing is what we'd expect," said Sally Auld, a senior strategist for interest rates at JPMorgan Chase.

"Lowe would also have a preference for fiscal, given he's spoken repeatedly about how monetary policy can only do so much, that it doesn't have the answers to all the problems."

She nonetheless predicts the RBA will end up cutting rates twice this year because between an election, drawing up legislation and then passing it through a Senate the government doesn't control, the cash wouldn't hit the economy until late this year.

That might be too late to arrest the momentum of the slowdown.

Growth slowdown

While hiring is strong, unemployment has fallen to 5 per cent and firms are continuing to plan spending, economic growth decelerated to about 1 per cent in the second half of last year from almost 4 per cent in the first.

Sydney house prices have slumped more than 13 per cent from their peak, prompting a sharp slowdown in residential construction; and wage stagnation and subdued inflation show little sign of lifting.

The fall in house prices could have a major impact on consumption.Credit:Rob Homer

The biggest concern is the drop-off in consumption, which accounts for almost 60 per cent of gross domestic product.

With rates already at 1.5 per cent, parliament might be better placed to respond.

The federal government has legislated some income-tax cuts and said in its mid-year fiscal and economic outlook it has about 0.5 per cent of GDP pencilled in for "decisions taken but not yet announced" — widely regarded as a nod to further giveaways.

Policy lever

Meanwhile, Labor is pledging to scrap tax concessions that it says are skewed toward the wealthy, freeing up money to deliver tax cuts and rebates for low and middle-income earners that may inject more stimulus into the economy.

Michael Blythe, chief economist at Commonwealth Bank of Australia, expects the RBA to keep standing pat and says the government should step in.

"Fiscal policy redistributes income around the economy," he said. "Use that policy lever to give some money to households, who we know represent the biggest downside risk to the economy."

Regardless of fiscal action, it may prove difficult for the RBA to resist a rate cut, according to Auld, who says the economy is experiencing "a cyclical shortfall" in domestic demand.

"At some point Lowe will sit there and say to himself: do I really want to be the guy, in six months' time, where everyone points the finger at me and says, 'you sat there and did nothing when blind Freddy could've told you that things are going south,"' she said. "He doesn't want to be that person."

Bloomberg 

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