If the RBA wants to boost confidence levels, it may not want to deliver back-to-back rate cuts. Here's why

Darrian Traynor/Getty Images
  • The RBA is widely expected to cut Australia’s cash rate for the first time since August 2016 on Tuesday.
  • Markets and the vast majority of economists believe the bank will deliver a follow-up cut by September.
  • In the past, the first move in a RBA easing cycle has always helped to boost household confidence levels. However, when the RBA cuts again a month later, it often leads to a sharp decline in confidence levels.
  • That suggests aggressive rate cuts may actually concern Australians about what the future holds.

The Reserve Bank of Australia (RBA) is widely expected to cut Australia’s cash rate for the first time since August 2016 on Tuesday.

Financial markets are fully priced for a 25 basis point rate cut to be delivered. Almost every economist polled by Bloomberg also expects the cash rate to be reduced to 1.25%.

By September, both markets and vast majority of economists expect a follow-up cut to be delivered, with a meaningful risk of a third cut also being priced in by the middle of next year.

If correct, Australia’s cash rate could be halved to just 0.75% by this time next year. A lot of policy stimulus is priced in, clearly.

Given those lofty expectations, it begs the question: if the RBA intends to deliver a series of rate cuts to help stimulate the economy, why not go hard and early, potentially delivering back-to-back 25 basis point cuts both in June and July?

A cash rate of 1%, after all, is already expected by September.

This chart from Westpac suggests that may not be a great idea if the RBA wants to boost household confidence by delivering lower borrowing costs.

Westpac Bank

It shows the percentage movement in the Westpac-MI Australian Consumer Sentiment Index following the 30 rate cuts the RBA has delivered since the early 1990s.

When the RBA has started or resumed an easing cycle after a prolonged period, indicated by red shading, sentiment levels have always increased.

However, when the bank has delivered a follow-up reduction a month after the first cut, more often than not, sentiment levels have fallen more often than not as indicated by the purple shading.

“Whereas the average response to ‘first moves’ is a clear positive with sentiment increasing on average by 5.6 percentage points, the response to follow on cuts is often negative, with an average decline of 3.5 percentage points,” said Matthew Hassan, Senior Economist at Westpac Bank, in a note released on Monday.

“The latter reflects a mix of ‘cooling off’ from an initial sentiment boost and other developments.”

That suggests that not only does the initial sugar-hit from a first rate cut diminish quite quickly, when the RBA eases policy aggressively, it often causes Australians to become pessimistic, rather than confident, towards what the future holds.

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