Interest rate cuts to continue as deflation takes hold in Australia: BT's Vimal Gor

The surprise drop in interest rates by the Reserve Bank last week, in response to the equally surprisingly low inflation figures, has reset a lot of economic thinking on just what might happen in markets later this year.

Until recently, the RBA was singled out for keeping the cash rate higher, while other central banks headed down to zero or beyond.

But what if last week's move marked the start of a new RBA rate-cutting cycle, where rates drop to 1 per cent or lower?

That's the view of Vimal Gor, head of fixed income at BT Investment Management, who spoke to Ticky Fullerton on The Business.

TICKY FULLERTON:  Now, you picked the RBA rate drop last week ahead of time. Deflationary pressures seem to have finally reached Australia?

VIMAL GOR:  Yeah. They've been a while coming and I've picked quite a few rate cuts and weak CPIs before this one actually arrived.

TICKY FULLERTON:  Well, this was a pretty important one?

VIMAL GOR:  It was. And it's been quite clear that the deflationary impulse has been flooding the world for, really, since the GFC. But it's finally hit Australian shores. And that's been driven by what's happening in Asia and the oversupply they have there.

TICKY FULLERTON:  So is the RBA right to have made this move now?

VIMAL GOR:  Yeah, definitely. I mean, I think that it probably should have been made earlier, but I think they're definitely right.

By increasing their growth forecast but decreasing their inflation forecast, it's quite clear that they're much more focussed on the deflationary pulse now and what it means for the Australian economy.

Central banks 'throwing everything' but 'can't engineer inflation'

TICKY FULLERTON:  Vimal, how serious is this threat of deflation for Australia?

VIMAL GOR:  Oh, it's massive. It's massive for Australia; it's massive for everywhere in the world.

I mean, when you look, central banks are throwing everything they possibly can at the world financial system and they can't engineer inflation.

TICKY FULLERTON:  I mean, there was supposed to be this movement by central banks to create this: what they call "escape philosophy," which I think is a fantastic phrase, out of the GFC. And it just hasn't delivered?

VIMAL GOR:  No. No, if you look US growth since the GFC, it's been running about 2.5 per cent per year. And whatever they throw at it, they can't get growth higher. And world growth is constantly being revised down by the IMF for OECD.

So every year we get more and more monetary easing and more and more packages, but actually growth slows and deflation and lower inflation, disinflation, become a bigger problem that we're looking at across the world.

TICKY FULLERTON:  So how is the world going to be stimulated. I mean, how are we going to get back on track?

VIMAL GOR:  That's the question. I mean, we're throwing everything we can at it from the monetary side. At some point there's going to have to be a fiscal response. But the way the political systems are across the world right now, I can't see there being bipartisan support to get fiscal policy moving.

And that's the problem: that we're continuing this low-growth funk until the fiscal policy levers are pulled.

'Over-indebted world' still hasn't reached 'peak debt'

TICKY FULLERTON:  Some people suggest a big, sharp shock on the monetary side and just actually change policy now. And, for example, Janet Yellin in the US should continue the march upwards?

VIMAL GOR:  I think that's completely the wrong... I mean, by hiking rates: I mean, yes, it does help the savings side of the equation and we know that ageing demographics: there are more savers. And that does help them.

But the other side of the equation, which are households and corporates who are largely indebted: I mean, that's a massive problem. So I think: you know, you look at countries which have tried large monetary experiments and you look at Japan as the poster child for that. They've done a massive monetary experiment and actually it's had no impact whatsoever. I think it's because the world is just over-indebted.

TICKY FULLERTON:  Well, this is the issue, isn't it? Because Janet Yellin's in a bit of a possie now because the longer she leaves rates low, the more borrowing, presumably, will continue to go on?

VIMAL GOR:  Yeah. And that's the problem: that you atrophy your money market system the longer rates are lower. But what's the response? I mean, there comes a limit to what central bankers can do. And central bank monetary policy was never meant to be the only policy levers pulled.

TICKY FULLERTON:  So what does this mean about debt? I mean, have we reached peak debt yet?

VIMAL GOR:  I would like to think we have, but I severely... I think we haven't. And if you look at total world debt since the GFC, it's actually been increasing.

And by central bank actions right now, where they're doing quantitative easing packages - for example, what's happening in Europe and Japan - they're forcing corporates to issue more debt so the central banks can buy them back for those programs.

So ultimately, I would expect further programs by the central banks, but at some point we need to get fiscal policy, which will have to be the end game, and the monetisation of debt at some point down the road.

'China the biggest debt bubble we've seen'

TICKY FULLERTON:  What about China? Because, of course, debt accumulation in China: we've had some reasonable inflation figures, but that continues to be a major issue now, doesn't it?

VIMAL GOR:  Yeah. China is the biggest debt bubble we've seen.

Now, China has followed the route of many emerging economies - virtually all emerging economies - but it's done it to multiples of the size. And all of those previous emerging economies have come down the other side and had some kind of crash.

Now, the issue with China is that I have no doubt that they will crash at some point. But the issue is: when does that crash happen? And how much further they can puff up the economy to forestall that crash?

TICKY FULLERTON:  So: back to Australia. And I know you've been buying short-term bonds in the lead-up to that rate decision. What are you thinking about a rate move, perhaps, again in August by the RBA?

VIMAL GOR:  I think trying to pick individual meetings is very difficult. I think that we just need to be focussed on the trajectory of rates, which is much, much lower. And I think that the world is just beginning to realise - and Australia is beginning to realise - this as the start of a new rate cutting cycle by the RBA, and it's not just a tweak at the edges.

So I think rates can probably head down to 1 per cent - and potentially even lower.

Source: ABC News

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