Not the last cut
About the author:
- Author name:
- By Michael Knox
- Job title:
- Chief Economist and Director of Strategy
- Date posted:
- 02 August 2016, 4:19 PM
Today (2 August), the RBA did as expected and cut rates by 25 basis points to a new all time low for the cash rate of 1.5%. The RBA Governor Glenn Stevens noted that the global economy is continuing to grow but at a lower than average pace. He noted that although conditions had improved in some advanced economies, they had worsened in a number of emerging economies.
In Australia, growth is continuing at a moderate pace despite a large decline in business investment. Domestic demand as well as exports are expanding and there is a modest expansion of employment.
Previous concern about rate cuts had been centered around the housing sector. It was only last year that newspapers were concerned that rate cuts might generate a "housing bubble". The Reserve Bank acted to deal with that concern by taking a firm approach to lending for housing investment.
Stevens notes that supervisory measures have strengthened lending standards in the housing market. He notes that as well as this, a number of lenders have also taken a more cautious attitude to housing lending. He says that recent information suggests that dwelling prices have only been rising at a moderate pace this year. Also, there is a considerable supply of apartments which will be produced over the next couple of years in eastern State capitals. This will keep dwelling price increases on a manageable path.
Glenn Stevens problem is not with economic output but with inflation. He suggests that recent data confirms that inflation remains quite low. Because of very slow growth in labour costs and very slow cost pressures elsewhere in the world, inflation will remain quite low for some time.
The difficulty for Glenn Stevens is that he has to aim to return core inflation from the current level of around 1.5% (on the average of the trimmed and the weighted mean) up to the RBA’s target of 2.5%. In order to do this, he needs to be running the cash rate below the level of core inflation. The problem he has, is not that just core inflation is low, it is that inflationary expectations indicated by the fixed interest market, have also fallen.
The danger is that low inflationary expectations will be anchored in the Australian economy. More stimulus needs to be provided to the Australian economy in terms of further cuts in interest rates to make sure this does not happen.
Our model of the Australian short rate explains some 93% of short rates over the period since the late 1980’s. The current level of wages growth suggests further downward pressure on core inflation. Inflationary expectations indicated by the fixed interest market also indicate further declines in core inflation. Our model tells us that this can only be reversed by further rate cuts.
We believe that the RBA will cut again when it meets in November after the release of the September quarter CPI.
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