RBA CUTS RATES TO 1.25%

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  • The Reserve Bank of Australia cut official interest rates by 25 basis points in June, leaving the cash rate at a new record low of 1.25%.
  • It was the first reduction in the cash rate since August 2016, and the first during Philip Lowe’s tenure as RBA Governor.
  • The bank flagged a lack of progress in reducing excess capacity in Australia’s labour market and downside risks for the global economy as two factors behind the decision to cut rates.
  • Philip Lowe said the main source of domestic uncertainty “continues to be the outlook for household consumption”.
  • The RBA sounds relaxed about current housing market conditions, noting the “rate of price decline has slowed and auction clearance rates have increased”.
  • Attention will now turn to a speech from Philip Lowe at 7.30pm in Sydney. Markets remain fully priced for the RBA to deliver another 25 basis point rate cut by September.

The Reserve Bank of Australia (RBA) has cut official interest rates.

The bank reduced Australia’s cash rate by 25 basis points, leaving it at a new record low of 1.25%

It was the first move in the cash rate since August 2016, and the first during Philip Lowe’s tenure as RBA Governor.

The decision was widely expected by both financial markets and economists.

“Today’s decision to lower the cash rate will help make further inroads into the spare capacity in the economy,” said RBA Governor Philip Lowe.

“It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target.”

Suggesting today’s rate cut may not be the last, Lowe said the RBA will “continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time”.

While stopping short of acknowledging that a further reduction in the cash rate will occur, it suggests a willingness from the bank to deliver additional monetary policy stimulus should the need arise.

Explaining today’s decision, Lowe admitted that despite “strong” employment growth over the past year and reports of “skill shortages in some areas”, there has been little progress in reducing spare capacity in the labour market of late.

“The unemployment rate had been steady at around 5% for some months, but ticked up to 5.2% in April,” he said.

In order to boost wage growth further and lift inflationary pressures, the RBA needs both unemployment and underemployment — where people have a job but would like to work more hours — to move lower, hence the need for additional policy support to achieve that objective.

Lowe believes that task is achievable.

“Strong employment growth over the past year or so has led to a pick-up in wages growth in the private sector, although overall wages growth remains low,” he said.

“A further gradual lift in wages growth is expected and this would be a welcome development.

On inflation, something that will likely require stronger growth in wages to move higher, Lowe described recent data as “lower than expected”, indicative of “subdued inflationary pressures across much of the economy”.

However, following the rate cut delivered today, Lowe remains optimistic that underlying inflationary pressures will slowly begin to build in the years ahead.

“The central scenario remains for underlying inflation to be 1.75% this year, 2% in 2020 and a little higher after that,” he said.

Underpinning his views on the outlook for wage growth, unemployment and inflation, Lowe expects the recent slowdown in the Australian economy is unlikely to be sustained, predicting growth of around 2.75% both this year and next.

“This outlook is supported by increased investment in infrastructure and a pick-up in activity in the resources sector, partly in response to an increase in the prices of Australia’s exports,” he said.

Many believe Australia’s trend growth pace is around 2.75% per annum. This is the level required to keep inflation and unemployment levels steady. So even with trend growth expected over the next 18 months, the RBA still remains optimistic that will be sufficient to achieve its policy objectives.

Even with today’s rate cut, not everyone agrees the economy will grow sufficiently over this period to prevent higher unemployment, explaining why markets still see the RBA delivering another 25 basis point cut to the cash rate by September. Another 25 basis point cut is also deemed to be more likely than not by the middle of next year.

As for the risks to the RBA’s growth forecasts, Lowe once again nominated household spending, the largest part of the Australian economy at a little under 60% of GDP, as the main source of domestic uncertainty.

“[It] continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices,” he said.

However, with the prospect of tax relief for households and firmer wage growth, Lowe acknowledged that “some pick-up in growth in household disposable income is expected”, something he believes should help to “support consumption”.

On Australia’s housing market, a major factor behind elevated levels of uncertainty towards the outlook for household spending, Lowe said the “adjustment in established housing markets is continuing”.

However, he, like many others, noted that there are some signs of stabilisation starting to emerge.

“Conditions remain soft, although in some markets the rate of price decline has slowed and auction clearance rates have increased,” he said.

“Growth in housing credit has also stabilised recently.”

That suggests the risk of a disruptive housing market correction, a scenario that would likely weigh further on economic activity should it occur, is diminishing in his opinion.

However, while Lowe seems comfortable with what’s happening in the housing market, he flagged concerns towards the global economy as one area that will need to be monitored closely.

“The outlook for the global economy remains reasonable, although the downside risks stemming from the trade disputes have increased,” he said.

“Growth in international trade remains weak and the increased uncertainty is affecting investment intentions in a number of countries.”

Lowe also noted that “inflation remains subdued” in most advanced economies despite “low” unemployment rates and a pick-up in wages growth.

With Australia’s unemployment rate still well above the level where wage growth is expected to accelerate, that was another acknowledgment that unemployment will likely need to fall further to prevent even softer inflation outcomes from occurring.

Following the release of the June policy statement, attention will now turn to a speech from Lowe at 7.30pm in Sydney.

Given markets are still anticipating at least another rate cut from the RBA this year, h will likely use this opportunity to either confirm those views or push back against the need for further near-term policy support.

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

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