Will the Federal Reserve cut push Australia to take the cash rate plunge?

The coming months will mark a test over Australia’s bet on so-called “dovish” rate hikes.

Reserve Bank of Australia Governor Michele Bullock has ruled out a rate cut in here in the near term. Picture: Bianca De Marchi/AAP

Reserve Bank of Australia boss Michele Bullock is looking increasingly isolated among her central bank peers for being one of the few remaining holdouts in cutting rates after the inflation super-cycle.

The coming months will deliver a test on Australia’s brave bet on so-called “dovish” rate hikes.

However their are real prospects of the cash rate (and therefore inflation) being higher-for-longer could ultimately do more damage to the economy than the shock therapy that has been doled out by central banks in other countries. Now after an extended pause, higher rates here would be far too crippling.

The US Federal Reserve has given the all clear for the rest of the world to keep moving on trimming rates with a 50 basis point cut overnight, its first in four years. It has signalled there are more to come.

The Fed’s cut marks a turning point in the global fight against inflation, with the world’s biggest economy confident things are steadily moving back into balance.

With the US on board there are now 10 key central banks including Canada, the UK, the European Central Bank, Sweden and New Zealand that have been trimming their benchmark borrowing costs since last year.

US Federal Reserve chairman Jerome Powell has issued the first US rate cut in more than four years. Picture: AFP

Futures market betting have the RBA’s first interest rate cut of this cycle fully priced in here by February next year, although with stronger-than-expected job numbers, that is now starting to drift out again.

Part of the reason for the lag with the rest of the world Australia was much later to start the inflation fight. Australia’s cash rate target was almost zero right up to May 2022 and by that stage others, including the US, were down the path on their rate hike cycle. Many were pushing through super-sized hikes, putting more pain on their economies while we went more gently.

Assuming we are at the cash rate peak at 4.35 per cent (although Bullock hasn’t ruled out a further hike), Australian cash rates topped out at a lower level than the United States which went from near zero to about 5.4 per cent - and quickly.

However, there’s good reason for the difference and that’s the transmission effect.

Australia is unusual given more than three-quarters of our home loans are in the form of variable rate mortgages that generally track the cash rate.

By contrast, in the US most home loans are written as fixed rates. Indeed the US is the king of the 30-year fixed rate mortgage.

Australia’s jobless rate held steady in August, although hours are being cut back. Picture: Getty Images

This means Australia is far more sensitive to changes in benchmark interest rates. In the US higher rates impact new mortgages as well as shorter term borrowing like car loans or business loans. So all things being equal, rates here need not move as much.

But given it is this late in the cycle, Australia should have much more confidence over its inflation fight than it currently has. So-called services inflation is stickier here and this comes down to wages and other labour costs adding into price rises.

A cooling US economy cleared the way for the Fed cut with the annual inflation rate there consistently slowing in recent months to be now running at 2.5 per cent.

In Australia inflation has seemingly been stuck or even drifting higher. The annual change rose from 3.6 per cent to 3.8 per cent in the June quarter. Remember, the RBA wants to get inflation back to a banks of between 2 per cent and 3 per cent.

Now it is all finely balanced for Australia.

ABS figures released Thursday showed Australia’s jobless rate held largely flat in August at 4.2 per cent, although net employment numbers dropped by 10,500. The unemployment rate has drifted up 0.5 per cent on the year. Still, a big part of this story is public sector jobs growth which is picking while private sector employment has been fast slowing. Companies too have been cutting back hours worked suggesting the economy is entering a grinding slowdown

The RBA’s Bullock said last month a rate cut is “not on the agenda in the near-term” noting the bank was worried inflation might stay higher for longer.

She also defended the decision not to go as high as other central banks. “We’ve deliberately tried to follow this narrow path of bringing inflation back down, at the same time as we are preserving what we can in the labour market”.

The RBA will soon find out whether its plan has worked. If not Australia will be stuck as a high rate economy while the world gets back to normal.

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Originally published as Will the Federal Reserve cut push Australia to take the cash rate plunge?