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Why Low Interest Rates Are Here to Stay

At the start of August, the Reserve Bank of Australia (RBA) kept interest rates on hold at 1.5%. The decision was widely expected, as there was no economic data to indicate the bank moving in either direction.

However, on Tuesday, the RBA released the minutes from that meeting.

Much like the August rate decision, there was little in the minutes to surprise the market.

But what surprised me was the central bank’s take on wage growth.

First, here’s why wage growth matters.

Since the mining boom, growth in salaries in Australia has been falling.

Wage Growth 2012–2017

Source: Trading Economics
[Click to enlarge]

As you can see, increases in wages dropped significantly between 2012 and 2014. At the time, the rapid drop from 3.75% to 2.5% per annum was noted by central banks and economists, yet no one was alarmed by the trend. After all, the incredibly high wages in the mining sector played a role in artificially supporting wage growth increases.

Throughout the mining boom, unskilled labourers were able to command six-figure salaries. As the mining boom subsided, the diamond drillers and truck drivers returned to their normal, lower-wage roles. And this was reflected in wage price growth.

Nonetheless, falling wage growth wasn’t a problem in the RBA’s view until the back end of 2015, when wage growth dropped to 2%.

Since 2016, the persistent wage deflation has become a notable problem for the RBA.

Economists like to call it ‘wage push’ inflation. Meaning we spend more money because we have more money to spend. This is the type of inflation economists like. But, if wages aren’t rising, chances are we will spend less. And if we spend less, consumption will fall. When we stop buying things, inflation falls.

Now, central banks and governments need inflation. You, however, don’t. Inflation erodes the value the money you earn. Governments, on the other hand, need inflation to make paying off debt easier.

Earlier in the week, the Australian Bureau of Statistics released June quarter data for the Wage Price Index (WPI). Public wages grew 0.6% for the quarter, bringing the year-on-year figure to 2.4%. In the private sector, growth was slower, at 0.4% for the quarter, with a year-on-year figure of 1.8%.

When mathematicians apply their statistics, this combined 0.5% wage growth increase brings the year-on-year WPI to 1.9%.

This is a problem.

If wage deflation persists, there is a chance that it falls below the current CPI rate. It means that, not only is your average dollar worth 1.9% less, but your earning capacity is falling behind as well.

Basically, it’s the double-barrel shotgun to your purchasing power.

The reason for bringing up the lack of wage price growth is that the RBA has suddenly come out with an overly-optimistic view on wage growth, noting in the minutes:

Wage growth had remained low but was still expected to increase a little as conditions in the labour market improved. Members observed that recent strong employment growth would be likely to contribute to an increase in household disposable income, and therefore consumption growth, over the forecast period.

The RBA also suggests that some employers are struggling to find the skillsets required to fill certain roles. Should this trend spread throughout the broader Aussie economy, it will lead to higher wages.

Yet the falling wage growth numbers tell a different story. While there may well be a bump in the September quarter data for wage growth, I believe this will come from increased activity in the construction sector (more on this in tomorrow’s Markets & Money).

While the RBA is hoping to see wages increase, I think they’ll be disappointed.

More importantly, this adds to my view that the RBA won’t be raising the cash rate anytime soon. In fact, I’m surprised the RBA haven’t continued to cut rates to stimulate inflation.

Should house price growth slow, I’m confident the RBA will begin lowering rates again. In the meantime, don’t expect the RBA to raise rates.

I’m not alone in thinking this way. Capital Economics CEO Paul Dales has an interesting take on this, one which I’m inclined to agree with:

Our feeling is that the economy isn’t strong enough to generate much wage growth and the big structural forces that have kept wage growth lower in other economies will keep it low here too. It follows that we expect weaker consumption growth and lower inflation than the RBA. This explains why we doubt the RBA will be able to raise rates next year as the markets expect.

The RBA’s growing emphasis on financial stability, which was illustrated by the comment that it needs to “balance the risks associated with higher household debt in a low-inflation environment”, will tie its hands further. It won’t want to raise rates too soon or too far for fear of pushing heavily indebted households over the edge.

Dales went as far to say that this financial stability will ‘…prevent the RBA from raising interest rates until late in 2019, which would be a year later than the financial markets expect.

With household debt at record levels, one suspects that’s exactly what the RBA will do.

IPO market boom

With all the doom and gloom surrounding the market at the moment, you’d think people would be running scared. Not so.

An indicator of market sentiment can be found in the most unlikely places. Such as the amount of initial public offerings (IPOs) taking place.

Put simply, companies don’t list in bad markets. It’s hard to attract capital, as investors are less willing to open their wallets. Plus, if a market downturn occurs, there’s a chance a company going for an IPO will be valued at less than it’s worth by the market once listed.

In the year to date, there have been 57 IPOs on the Australian Securities Exchange. That is well above the 34 IPOs for the same time last year. Furthermore, IPO Watch said that 86% of all new Australian IPOs were valued at less than $100 million. In other words, the small-cap market is gaining some hot new entrants.

Helping this small-cap IPO boom has been recent government legislation allowing the sale of cannabis for medicinal use. Four listings alone in the pharmaceutical, biotech and life-science sector raised $37 million at their IPO. These four companies were all ‘pot stocks’.

There’s no doubting this breakthrough. Cannabis has opened the door to a new age of medicine.

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