Charlie Nelson, managing director foreseechange (www.foreseechange.com)
December 2000
Pessimism about the growth rate of the Australian economy in 2001 is mounting, especially amongst business managers. Business confidence has slumped (although that happened in 1998 amidst the Asian economic crisis with no deleterious effect on the economy). In addition, retail spending is patchy and construction has slumped. These indicators have led to speculation amongst economic commentators that interest rates will be cut during 2001. That would be the worst thing that the Reserve Bank of Australia (RBA) could do to the economy in 2001.
The RBA has raised official rates a total of 1.5% between December 1999 and August 2000. While rate rises slow some sectors of the economy quickly, the full impact takes at least 18 months to occur. Housing construction and household durables feel the pinch quickly but other components of retail spending take 15 to 18 months to slow as households with mortgages strive to maintain lifestyle for as long as possible. Thus the full impact of the sequence of rate rises will not be felt until the second half of 2001.
In fact, interest rate rises initially boost consumer spending because households with savings (mostly, but not only, self-funded retirees) get an income increase and quickly adjust their spending. Should the RBA cut rates in mid to late late 2001, households with savings will reduce spending in reaction to their lower incomes – at the same time that households with mortgages are cutting spending in their lagged reaction to higher interest rates.
Consumer spending makes up 60% of the Australian economy and exports contribute a further 20%. The Australian economy is currently being boosted by strong export growth, stimulated by the plunge in the value of the Australian dollar during 2000. It is very likely that the Australian dollar will recover in the second half of 2001 – due to the peaking in oil prices and the lagged impact of higher interest rates (see Australian dollar set for Recovery). Should this happen, export growth will falter.
The worst case scenario for the Australian economy is a resurgent Australian dollar combined with interest rate cuts. This triple-whammy would see both households with debt and households with savings adjusting their spending downwards at the same time that export growth is slowing. This may or may not play itself out in a recession, but economic growth would be significantly slowed.