The RBA is moving closer to cutting rates as unemployment lifts

THOMAS OLIVA / AFP / Getty Images
  • The RBA still is moving closer to cutting official interest rates for the first time since August 2016.
  • At its May monetary policy meeting, the RBA Board said a “further decline in the unemployment rate would be consistent with achieving Australia’s medium-term inflation target”.
  • Australia’s unemployment rate increased to 5.2% in April, up from 4.9% in February.
  • RBA governor Philip Lowe will deliver a speech in Brisbane at 1.10pm on Tuesday.

The Reserve Bank of Australia (RBA) is moving towards cutting official interest rates for the first time since August 2016, suggesting only a further decline in unemployment will be enough to boost inflation.

“Members discussed the scenario where inflation did not move any higher and unemployment trended up, recognising that in those circumstances a decrease in the cash rate would likely be appropriate,” the RBA board said at its monetary policy meeting earlier this month.

Based on the evidence seen in March and April, where Australia’s unemployment rate increased from 4.9% to 5.2%, that’s not happening at this point, increasing the likelihood of rate cuts given how weak inflationary pressures already are.

The RBA said evidence from abroad was one factor underpinning the view that unemployment will need to keep falling in order to boost wages and return underlying inflation to its 2-3% medium-term target.

“Members observed that the recent international experience was that inflation had remained low despite historically low rates of unemployment,” the board said.

“Given the international evidence and the recent Australian inflation data, members agreed that a further decline in the unemployment rate would be consistent with achieving Australia’s medium-term inflation target.”

While Australia’s cash rate, at 1.5%, already sits at record low levels, the RBA acknowledged that lower borrowing costs will still help to stimulate the Australian economy.

“Members recognised that the effect on the economy of lower interest rates could be expected to be smaller than in the past, given the high level of household debt and the adjustment that was occurring in housing markets,” the board said.

“Nevertheless, a lower level of interest rates could still be expected to support the economy through a depreciation of the exchange rate and by reducing required interest payments on borrowing, freeing up cash for other expenditure.”

Given the pronounced slowdown in household spending seen in the second half of last year, and with potential income tax rebates likely to be delayed, according to media reports, a reduction in borrowing costs will still help to support spending levels, in other words.

The Board acknowledged that “household income growth had remained low and the March quarter inflation data indicated that the inflationary pressures in the Australian economy were lower than previously thought”.

Importantly, the board suggested that economic growth and inflation would likely remain weak without the assistance of rate cuts.

“Without an easing in monetary policy over the next six months, growth and inflation outcomes would be expected to be less favourable,” the board said.

Following the release of the RBA’s May meeting minutes, market probability of a 25 basis point reduction in the cash rate on June 4 has firmed to 72%, according to interbank futures.

The Australian dollar has also trimmed earlier gains that were sparked by an announcement from Australia’s banking regulator, APRA, that it may remove the 7% floor rate that all new mortgage borrowers are assessed by lenders.

RBA Governor Philip Lowe will deliver a speech in Brisbane later Tuesday, providing him the opportunity to confirm or push back against current market expectations that a rate cut is likely to be delivered next month.

Lowe will also likely comment on APRA’s proposed changes, especially as Lowe has put greater weight on financial stability risks in regards to appropriate monetary policy settings.

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