Grim market rate warning for RBA’s Bullock

Michele Bullock, the new Reserve Bank governor.

As Michele Bullock prepared for her first Reserve Bank board meeting, global markets sent her a chilling message: “What ever you might decide in the first week of October, you must prepare to lift interest rates in the future”.

If you don’t obey that message, then markets will trash the Australian dollar and send Australian inflation spiralling upwards, requiring much higher rates. And to make sure she understood the market’s message, the Australian dollar has slumped well below the US64c benchmark and our two and 10 year bond rates have spiralled upwards. This will boost bank borrowing costs, particularly those with lower local deposit bases.

The US government demand for funds is pushing US bond interest rates higher and hitting the value of Australian bonds and currency at a time when our inflation rate is significantly above the US.

At the same time, the federal and state governments are fanning inflation with their spending and the federal government is planning to reduce productivity and skyrocket costs via its industrial relations legislation, which thankfully is stuck in the Senate.

While the message from the markets is crystal clear, the information Bullock can gain from the Australian economy shows a split in spending habits.

Solomon Lew was on the RBA board between 1992 and 1997. If he was there today, he would be warning Bullock that the downturn in retail sales shown in the August official figures has continued in September.

And he would reinforce that trend by pointing to a further fall in the Morgan ANZ Consumer Confidence Index and the fact that Australians who are under mortgage and rent stress are dipping into savings and using their credit card to survive. Lew controls Premier Investments which operates retailers like Just Jeans so the Reserve Bank board would listen closely to the Lew message which signals that on the local front, and ignoring the global market message, Australia should be looking to cut rates.

But if RBA officials move outside their Martin Place bunker to the wider world, they will find there are a large number of retailers that are trading extremely well because their customer base is not being impacted by mortgage or rent stress and where income and/or savings are strong. This group restrained their spending between Mother's Day and the end of August but have now ramped it up. Tapping their money pool requires the right products, good marketing with a strong emphasis online.

And these consumers are also examining their accommodation, so their dwelling purchases have pushed up house prices in all states although, in Victoria, confidence in the state government has slumped, so Victorians are not spending as strongly as the other states including Queensland which was a slow starter.

This divide between the haves and have-nots is going to present Bullock with difficult decisions all the way through 2024.

Solomon Lew, like other clothing retailers, has an extra problem. To the extent that his operation embraces prosperous customers, there is a current tendency for this area of the market to spend less on clothes because they already have too much.

RBA Governor Michele Bullock at the RBA offices in Martin Place. Picture: John Feder

That barrier can be overcome, but it requires very skilled marketing. One of the areas that is trading very strongly at present is travel, both domestic and overseas. Given it is the prosperous group of Australians who will be dominating this area, overseas travel represents a threat to the continued buoyancy in local spending by affluent people. But it is very good news for Qantas.

However, if the Australian dollar keeps falling, it will curb the desire of Australians to travel overseas.

Normally the food area is insulated from downturns, but this time the severity of the blows being landed on those with large mortgages or who are renting properties is cutting spending. In addition, I detect the ability to gain low-priced quality goods at retailers like Aldi is becoming a conversational point among those not being affected by rent and mortgage stress. Coles, Woolworths and IGA will need to be very careful with their margins, or they will lose market share which will not come back quickly.

But all retailers, along with wider areas of the business community, are seeing their costs rise because the Australian dollar has already fallen from above the US70c level reached earlier this year.

Those that have not hedged the currency risk in their Christmas stock purchases face some nasty purchase cost rises. Accordingly, there may be big differences in the performance of retailers in the same category over the Christmas.

But in 2024 those currency hedges will run out and the full brunt of the increased cost of imports will hit the nation along with all the other cost rises impacting businesses.

The bungling of the renewable energy program plus strong oil prices looks like sending energy costs higher, insurance costs are ballooning, and wage demands are creeping up at a time when skills still remain short.

So Bullock not only faces the higher interest rate message from the markets but early signs that it is going to be very hard to reduce inflation below four per cent with dangers that it could start respiralling upwards.

Lower interest rates suddenly become off the agenda, which will impact a large part of the Australian sharemarket along with bonds.