Monday 20 March 2017 by Opinion

The rise and fall of rates – US versus Australia

The US Federal Reserve is increasing rates – the only contention being how much more they move, with economists predicting between 0.5%pa and 1.75%pa more over the next two years. This is in sharp contrast to Australia where the RBA is caught between a housing bull market and weakening conditions, and economists predicting anything from a 0.50%pa rate cut to a 0.50%pa increase

USA vs Australia

The US economy continues to grow steadily. Inflation is picking up to the US Federal Reserve’s (Fed) target of 2.0%pa, employment is growing strongly, wages are climbing faster than inflation, business investment is climbing steeply and the housing market remains strong but not overheating.

By contrast, as shown in Figure 1 Australia faces record lows in inflation, wage growth and rental growth; as well as significant falls in employment, disposable income, business investment and housing starts. 

In short, Australia is struggling to create jobs growth to keep up with population growth, meaning there is too much slack in the labour market, wages aren’t rising and inflation remains weak.  Since the end of the mining investment boom, housing construction has picked up much of the employment slack, however is now slowing as oversupply looms across most of the country. 

Economic scorecard – latest measures for lead indicators of economic health

(Latest result vs one year ago)
(Latest result vs one year ago)
Inflation (core, excluding excises) 1.7%, up from 1.4% 0.8%, down from 1.6%
Underemployment 9.2%, down from 9.8% 14.9%, up from 13.7%
Wage growth 3.2%, up from 3.1% 1.9%, down from 2.2%
Disposable personal income per capita (real increase) 1.8%, flat 1.2%, down from 1.4%
Rents 4.1%, up from 3.9% 0.6%, down from 1.2%
Business investment 6.5%, up from -2.1%4 -15.5%, down from -12.8%
Retail spending 5.7%, up from 2.5% 3.2%, down from 4.2%
Consumer confidence 98.5, up from 95.1 99.7, up from 97.5
Business confidence 57.7, up from 49.8 110, up from 105
R&D as % of GDP 3.1% of GDP, up from 2.9% 2.2% of GDP, flat
House price increases 6.0%, up from 5.7%5 6.3%, down from 8.5%
Housing starts, growth rate 11%, up from 10.5% -0.4%, down from +3.4%

Sources: ABS, Bureau of Economic Analysis, Federal Reserve, NAB, RBA and S&P
Figure 1


There is little doubt that, failing a complete crisis, US interest rates will rise at least twice more in the next year.  If that pushes the USD up too fast, the Fed will likely hold back further increases, but otherwise there could be as many as another three more rises in 2018. 

On the other hand, aside from concerns the RBA’s perceived housing bubble could worsen, there are stronger reasons for cutting interest rates in Australia than any time since the 2009 crisis and – in many cases – since the 1992 recession.  If higher US rates mean the AUD falls to around 70 cents, the RBA could hold steady and allow lower currency to lift economic growth.  If not, the RBA may be forced to cut rates later in 2017, despite their housing market concerns. 

Under this range of scenarios, the 0-5 year interest rate differentials between the US and Australia are likely to tighten and potentially even cross over.  Given that interest rate differentials are a major driver of currency levels, the odds of a significantly lower AUD are rising with each new data point.