Political Winds in Australia and the Likelihood of Lower‑for‑Longer Interest Rates

Although the Commonwealth Government can borrow for 10 years at the lowest rate on record, the burden of policy support has continued to fall on the Reserve Bank of Australia.

As Australians prepare to go to the polls on 18 May, the middle of this election campaign is an opportune time to revisit the ongoing conflict between politics and effective economic policy. Its implications are also highly relevant as Australia’s economy continues to slow.

Politics are inherently focused on the short-term goal of appealing to the electorate, which can lead to populist measures, rather than on longer-term policy, which can potentially benefit the overall economy. In Australia, it has lately become politically popular, and apparently a vote-winner, to achieve “budget balance.” This myopic focus on austerity rather than on longer-term investments that can raise productivity, like infrastructure, is likely to have important consequences for the economy. Indeed, it has been the death knell of many economic expansions historically.

Lack of balance

While there will no doubt be bouts of potentially vote-winning spending promises by both the Liberal and Labor parties, these are unlikely to tackle the long-term reality: For Australia’s economy to sustainably grow, there needs to be a balance of monetary and fiscal policy settings throughout the cycle. High school economics students learn about the importance of this mix between fiscal and monetary policy, yet politicians seem to have thrown out the textbook.

Although the Commonwealth Government can currently borrow in the bond market for 10 years at around 1.8% – the lowest rate on record – the burden of policy support for the economy has continued to fall on the Reserve Bank of Australia (RBA), and by extension, the already heavily indebted Australian household. Some observers are lately hoping policy rate cuts will allow households to lever up even more to support the flagging housing market.

The RBA is a highly credible and pragmatic body that has been responsive to economic reality. The expectation of an underwhelming fiscal response to Australia’s slowing economic environment means the RBA is likely to take on the task once again.

Investors need to focus on what is likely to happen, not what should happen. So as long as it’s politics as usual, we think investors in Australia need to be prepared for even lower interest rates for even longer.

The Author

Robert Mead

Co-head of Asia-Pacific Portfolio Management

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