Why rate and tax cuts should be on table in 2018 – Credit Suisse

“Large” tax cuts and a further drop in interest rates in 2018 are needed to encourage more spending from those constrained by heavy mortgage debt loads, according to a new Credit Suisse report.

While RBA Governor Philip Lowe has made it clear that – without rushing – he’d like the next interest rate move to be a hike, the global broker said forecasts from the Reserve Bank were “overly optimistic” and pointed to a hole in its future plans – the rising rate of  household saving.

“We think that the RBA is too optimistic in its consumption outlook,” Credit Suisse researchers wrote in a report on Sunday, which argued Australian household spending remains constrained by a desire to save and pay down heavy mortgage debt loads.

The analysts predicted Australian households could grow their savings rate to 3.5 per cent of their disposable income in 2018 as they sacrificed discretionary spending – a trend that could lead to an economic slowdown and encourage another rate cut.

“Our framework suggests that household saving is barely covering minimum mortgage principal payments, with the saving rate roughly 2 per cent too low relative to fundamentals,” the analysts wrote.

“A further 1.5 per cent upside is possible on the back of tighter lending standards and falling house prices.”

If the savings rate jumps 3.5 per cent this year, as Credit Suisse predicts it could, inflation would remain beneath the Reserve Bank’s target and rate cuts would remain on the cards.

While many economists believe official interest rates will start rising later this year or early in 2019, the household spending issue is indeed significant, according to IFM Investors chief economist Alex Joiner.

“It’s evident from the Reserve Bank’s own forecasts that they’ve been too optimistic on household consumption for too long, and have consistently had to revise their forecasts lower,” Mr Joiner said.

“Even now, they have household consumption spending going to 3 per cent year-on-year over the next couple of years … and that’s going to need to be predicated on household income growth and wages growth, which we haven’t yet seen.”

The idea that interest rate and tax cuts would come to the rescue were quickly dismissed by NAB chief economist Alan Oster, who said that while household consumption was a concern it was nowhere near enough to put another rate cut on the table.

“The chance of getting more rate cuts is virtually zero,” Mr Oster told Domain, adding that another rate cut would “just fire up the housing market again”.

“We think the RBA will probably hike twice this year – we’ve got them tentatively in August and also tentatively in November. But it’ll depend on whether wages pick up – if they don’t the RBA could sit on its hands.”

Bring on the “large” tax cuts

To further kick-start household spending, and in turn pump some oxygen into retail and services sectors, Credit Suisse analysts also recommend the federal government cement tax cuts for households.

“Given our view that the saving rate is likely to rise, perhaps the best way for policy makers to embrace this scenario is to offer large tax cuts,” the analysts wrote.

“Tax cuts are on offer in the upcoming election cycle, but there is considerable uncertainty, and households will need more conviction about their permanence before choosing to spend. But even before getting them to spend, the government ought to consider the benefits of simply stabilising the cashflow situation for households.

“If they need to save more, then given them the cash to do so.”

It’s a plan that also gets a tick from IFM chief economist Alex Joiner, who says addressing bracket creep could help spur a positive shift from consumers.

“Households have started to pay slightly above average on income tax as a percentage of their household income,” he said.

“Now, the government could redress that a little bit and that would be good for households in supporting consumption growth when wages are weak, but also in allowing some households to choose to engage in some balance-sheet repair.”

NAB’s Alan Oster again poured cold water on this part of Credit Suisse’s plan.

“I don’t think [the government] can afford it, for starters.”

And, he said, if the government were to find a way they’d be best placed to try to aim those tax cuts at the bottom-end of the earning landscape, where consumers tend to spend everything they’ve got. But still, [the government] “doesn’t really have a lot of scope to do that”, Mr Oster said.