Unlike the U.S., the Australian economy has a few resilience levers to pull.

But it’s critical that the macro environment is not tampered with too much so that we get the benefit of our natural resources endowment (hard and soft commodities) as well as the continued export of our intellectual capital around the globe.

The biggest lever at present is interest rate policy.

At 12.30 today, Governor Lowe announced official interest rates would be lifted by 0.25% to 0.35%.

And so it begins, but for how long? Is this a swipe at cyclical inflation? Is it more, and for how long?

Here are some charts that I think may partly define some of the swim lanes for Governor Lowe’s interest rate thought process, going forward, and may reveal some insights on how much and how long.

But to be clear – the RBA is not independent, and we are in an election year, so no one really knows how this all plays out over time.

14 charts

There’s been a massive increase in house prices in Australia (and many other advanced economies). It’s crowding out the millennial demographic, i.e., our future.

Massive increases in commodity prices have fed into fuel, food, shelter (buy and rent alike) and consumer product and service prices.

Here in Oz, we live on an oil dependent island that’s not immune to supply shocks. There’s pressure to get these prices under control.

And from the February monetary policy meeting minutes it’s clear that the RBA believes the external situation will not help.

They feel strong commodity export prices will be crushed by higher import prices, with a significant decline in our terms of trade. That suggests the RBA might want to see a stronger dollar which would be helped by higher interest rates.

In fact, growth in spot bulk commodities prices while still positive slowed in April, after a massive acceleration in March.

Other than for Lithium, bulks are bleeding a little. Copper remains in structural under supply and that is likely to last for at least a decade.

But internally, the rate of investment in key factors of Australia production continues to follow a downward secular trend.

This is due to a convergence of an ageing population, the great resignation, capital and labour saving technology, and other capital and labour saving advances.

And let’s not forget that seemingly higher employment and participation rates are unlikely to be accurate given the small increase in participation over a rapidly ageing/retiring population, and the increasing part-time nature of that participation.

So, if our population had an average age of under 30 years old (like India) the working population denominator would be massive. It’s just that the denominator here is lower due to age, COVID disrupted industries and resignations.

And this also leads to secular wage growth stagnation, once you take out the COVID plunge/recovery noise.

As for COVID, you can tell where most of the household disposable income growth came from by looking at the yellow bars below, shown in the February 2022 monetary policy statement minutes.

That’s a lot of stimmy. That stimmy is gone and what’s left might be given back if investment markets recalibrate. If that happens, stimmy comes back again, just in a different form.

And now we can see a CPI slingshot of 5.1% for the 12 months to March 2022 due to largesse of blunt instrument QE and fiscal stimulus.

It’s what got politicians animated all of a sudden, but not to worry, we are still well below the U.S. which is close to 9%.

That chart is also telling Lowe that in Australia, real wage growth is around -3% per annum - despite his comments today about it improving.

So, ageing population, overstated employment and negative real wage growth with mooning property prices and rents – and Governor Lowe has to assess how high interest rates go up in Australia.

It’s a tough one.

But higher mortgage rates with real wage decline and higher commodity prices crowding out growth will destroy demand and confidence, the longer it goes.

Next, any tightening of lending becomes a double whammy when confidence and serviceability is already low and set to fall lower.

That in turn will probably pull down household savings rates, which are healthy now but already declining after the end of fiscal stimmy.

Seriously, other than for the sausage sizzles, how often can you go to Bunnings or buy first world toys from Temple & Webster or Kogan?

Consumer discretionary will start to fall as a result of demand destruction form interest rate rises once they transfer into variable mortgages, personal loans and other household budget items.

And with all of this there’s no surprise about the sharp drop in consumer sentiment.

And yet a further chart suggests that if we stop consuming and if Government stops spending, we get close to negative growth.

Do that for a few months and you know what you get.

And with building approvals down, higher interest rates won’t stimulate that aspect of the economy.

And with many builders making hay from the first home owner scheme where they signed up more dwellings than they could complete, plus the increasing price of building materials - there’s too much chili in that broth.

So, it might be a long time before the aqua line below (completions) catches up to the red line (approvals).

You can also see the purple line (commencements) starting to roll over after the pandemic sugar hit. This does not bode well for over-extended builders.

Swim lanes?

So, what we had was a massive supply shock from COVID, which was extended by Russia/Ukraine.

Next, growth continues to be crowded out by mooning commodity prices and in turn this has created a longer life for high cost inputs and a fanning of the inflation flame.

Too much COVID, too much stimulus, too much Russia, not enough China and too soon for India.

Do it long enough and you destroy demand and as demand drops, the demand line moves down closer to the supply shock line, and prices also adjust down.

That stops your economy.

The risk of relying on central banks to get it right is high because they are almost always 6 to 12 months behind the real economy. That means any QE and QT moves acts like a highly elastic slingshot - and it’s why people say “well, that happened quickly”.

No! It just crystalizes quickly, after months or years of stoking.

This is precisely what the U.S. Fed is engineering now – intentionally. There will not be a soft landing. The Fed is seeking to destroy demand to cool down prices at the behest of President Biden.

However, the potential probabilities that Governor Lowe here in Australia has to assess include: (a) whether demand destruction elsewhere in the world (and some here) will do most of the heavy lifting for him in a timeframe that will be politically acceptable to the government of the day; and (b) if not (a) then might he need to join the belt tightening party, for real?

Swim lanes?

Higher rates, stronger AUD and while less dollars received from selling USD denominated commodities, less stronger dollars required to buy more expensive finished good imports, plus savers rewarded and a more socially inclusive policy.
Lower rates, weaker AUD (unless China demand reignites) and more AUD for each USD of commodities sold, imports more expensive, plus borrowers and risk asset purchasers rewarded, with social exclusion.

Time will tell. We’re in a good shape right now, but sometimes less is more.

Meanwhile, all eyes will be on Fed Chair Powell tonight and tomorrow as markets find out whether an 0.5% U.S. federal funds rate step up lands on Wednesday, along with more details about removing liquidity from markets.

Yippee ki-yay!

Mike

14 charts to light Lowe’s way on interest rate journey

14 charts

Swim lanes?