The latest OECD report on Australia takes a rather sunny view despite forecasting GDP and consumption growth in 2018 and 2019 that is lower than was projected in the May budget. But its argument for increased interest rates appears rather out of date and is certainly not reflected by current market expectations of rates remaining low while wages growth remains weak.
If you want a bit of an economic pick-me-up, the OECD Economic Outlook is worth a read.
The report opens with the positively glowing statement that “the global economy is now growing at its fastest pace since 2010, with the upturn becoming increasingly synchronised across countries”.
The authors note that this lift in global growth has been “long awaited,” has been “supported by policy stimulus” and is “accompanied by solid employment gains, a moderate upturn in investment and a pick-up in trade growth”.
All around good news.
And Australia does not miss out on this optimism. The OECD opens its section on Australia by predicting that “the economy will continue growing at a robust pace” and that “business investment outside the housing and mining sectors will pick up, with exports boosted as new resource-sector capacity comes on stream”.
The report suggests that “the strengthening labour market and household incomes will sustain private consumption, and inflation and wages will pick up gradually”.
And yet the OECD outlook (which comes via consultation with the Treasury) offers a slightly more pessimistic outlook for the economy than we had in the May budget.
There is a bit of fudging because the budget uses financial-year projections and the OECD’s are for calendar years, but the “robust growth” the OECD projects for GDP is just 2.8% in 2018 and 2.7% in 2019, while the budget projected 3.0% growth in 2018-19.
Similarly, private consumption growth in the OECD report is projected to be 2.4% in both 2018 and 2019 – below the 3.0% growth projected in the May budget.
But the OECD does forecast stronger export growth and lower unemployment. Where the May budget projected an unemployment rate of 5.5% in 2018-19, the OECD has it falling to 5.4% next year and 5.3% in 2019.
But the OECD’s recommendation for the Reserve Bank to raise interest rates is one that does not fit with much of its own commentary about wages growth and inflation.
It suggests that the RBA is “projected to start raising the policy rate in the second half of 2018, and expectations of this move, together with macro-prudential measures, are helping cool the housing market”. And it notes that “amid gradual policy tightening and a slow pick-up in wages and prices, consumption growth will remain subdued”.
The suggestion that the RBA is projected to start raising interest rates is rather out of date.
In September the market was pricing in almost two interest rate rises by the start of 2019, but by the end of October this had fallen to an expectation of one rate raise by the end of next year and a slight chance of another rate rise in the middle of 2019. And now there is only about a 50% chance of a rate rise by December next year:
There is unlikely to be a change in these expectations on the basis of any projections in the OECD report.
The report, for example, notes that “under-employment has edged higher and wage growth and inflation remain steady”. It also suggests that “some highly indebted households could face financial stress when interest rates rise” and “that household indebtedness and signs of a cooling housing market are keeping consumer sentiment relatively soft. Household consumption growth remains subdued”.
And yet it then bizarrely suggests “on the other hand, a stronger pick-up in wages and incomes could result in higher consumption and growth”.
Well, yes, but nowhere does the report suggest that is about to happen.
Indeed, the link of under-employment and wage growth is well noted, given the very strong relationship between the two measures over the past decade and half:
Currently the under-employment rate is at a record high of 8.7%. For private sector wages growth to return to the 3% the May budget predicts for 2018-19, history suggests it would need to fall to around 7.6% – 140,000 fewer people under-employed.
The OECD also notes that the housing market is cooling due to expectations of rising interest rates and the macro-prudential regulations that have limited investor lending, and that “rising household indebtedness” is “keeping consumer sentiment relatively soft”.
Certainly our household indebtedness is rising – to the record level of 194% of household disposable income. That’s 26% points higher than it was five years ago:
Given this level of debt, it is odd to think that raising interest rates would result in higher consumption growth.
As ever, the OECD also advocates for tax reform – including lowering the company tax rate. But crucially, it is within the context of shifting our dependence on tax from income to consumption taxes and it recommends broadening the base of the GST.
Such a move would unlikely do much to promote consumption growth and at any rate is politically dead, given the main way to broaden the GST is to put tax on fresh food – a very regressive move that would require significant outlays to compensate poorer households:
The OECD report for Australia has a positive outlook almost in spite of itself. The growth projections are a mixture, but overall no better or worse than was estimated in the May budget but the OECD sees good times ahead.
And yet its major recommendation that the Reserve Bank should increase interest rates despite evidence of ongoing weak inflation and wages growth is one that would likely undermine that rosy outlook – especially if it were to occur while our under-employment levels remain at record highs.