What is the outlook for the Aussie dollar, interest rates and wages?

With the economy muddling along, house prices falling and inflation remaining stuck below the bottom of the Reserve Bank’s target range, one sure bet is that official interest rates will not rise any time soon.

If the house price falls evident since the end of 2017 intensify, there will be further damage to consumer sentiment and spending along the way. In these circumstances, the RBA would move to cut official interest rates as it worked to minimise the fallout from the loss of wealth and potential damage to bank balance sheets.

While the RBA is still of the view that the next move in official interest rates is more “likely” to be up, it is not fanciful to think a cut to 1%, or less, will be needed to support the economy if its rosy scenario falls short.

The Australian dollar in this climate seems set to fall further. Already down more than 10% from the peak at the start of 2018, a break towards 65¢ against the US dollar is on the cards for 2019. It could fall even further if the US Federal Reserve hikes interest rates towards 3% and the RBA cuts to 1%, both of which are moving into focus.

In many respects, the fall in Australian house prices is a welcome and necessary development. Prices had risen strongly and household debt was at a level that restricted the ability of consumer spending to grow. Weak wages growth only added to the concern that the household sector was under pressure and with it the rate of economic growth would be held back.

As the economy moves into the latter part of 2018, there are growing risks from the house price decline.

With around $7 trillion of household wealth tied up in residential property, a drop of even 10% would see wealth drop $700 billion or around 30% of annual GDP.

This wealth destruction would be likely to hold back consumer spending and cause the banks concerns, given the amount of lending at the top of the market. A further intensification of the credit crunch would be near certain.

The risks to the economy extend beyondhousingandconsumerspending.

One of the very disappointing aspects of the economy in recent years has been the weakness in private sector business investment. Despite solid growth in the global economy and record low interest rates, business investment remains around levels consistent with the immediate aftermath of a recession.

Lower interest rates would help turn this around, as it would free up cash flows for businesses on their overdrafts and other debts and it would encourage much needed new investment.

Without an upswing in business investment, it will be difficult, if not impossible, for the Treasury and RBA forecasts of 3%-plus GDP growth to materialise.

Suffice to say the economy is muddling along with growth below par. This is feeding into chronically low inflation and wages growth, which is feeding back into a lack of spending and business investment.

Easier policy is needed. With both sides of politics looking to return the budget to surplus, even in the heat of the upcoming election campaign fiscal stimulus seems unlikely.

The only other option appears to be interest rates, so get set for the possibility of an about-face from the RBA some time soon, which will mean lower interest rates into 2019.