RBA interest rate cut: The statement decoded

A look behind the statement to decode what the RBA official cash rate cut means in detail.

The RBA highlighted its primary aims of supporting growth in jobs to lift income growth and get inflation back up to target. Picture: Natee Meepian

As the Reserve Bank on Tuesday cut the cash rate to a new record low of 0.75 per cent, we decode the central bank’s statement.

1. RBA: At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.75 per cent.

(THE AUSTRALIAN: The decision to cut the cash rate to a record low of 0.75 per cent after cuts in June and July was in line with market expectations, since the money market was 80 per cent priced for a cut).

2. While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US-China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken further steps to support the economy, while continuing to address risks in the financial system.

(RBA Governor Lowe has kept his long-held description of the global outlook as “reasonable”, while continuing to note the “risks” to growth, particularly from the US-China trade war. After recent recession warnings from the US bond yield curve which recently “inverted” for the first time since 2007, US manufacturing PMI followed the rest of the world into “contraction” territory in August. While the Fed and the ECB have joined other major central banks in adding policy stimulus in recent months, the major developed economies and China are yet to engage in any significant fiscal stimulus to deal with this downturn).

3. Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation. Long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at its lowest level of recent times.

(Dr Lowe has underlined the low level of interest rates globally and expectations of further cuts. The implication that this would otherwise put upward pressure on the Australian dollar forms part of the argument for the RBA to cut. With further interest rate cuts widely expected in Australia, the US and Europe — and quantitative easing restarted in Europe — about $US15 trillion ($22 trillion) of the world’s bond market trading on negative yields. Australia’s 10-year bond yield hit a record low of 0.85 per cent and the Australian dollar hit a decade-low of US66.77c in August. But the dollar was supported by strength in iron ore prices, a pause in RBA rate cuts and a narrowing of the Australian-US 10-year bond spread from a four-decade low in August. The dollar fell to a 4-week low of US67.03c after the latest interest rate cut).

4. The Australian economy expanded by 1.4 per cent over the year to the June quarter, which was a weaker-than-expected outcome. A gentle turning point, however, appears to have been reached with economic growth a little higher over the first half of this year than over the second half of 2018. The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets and a brighter outlook for the resources sector should all support growth. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending.

(In justifying the rate cut, Dr Lowe noted that the weakest annual growth rate in the year to June was “a much weaker than expected outcome”. And he explained that the “gentle turning point” he’s been talking about in recent speeches was only referring to slightly higher growth in the first half versus the second half of 2018. A previous reference to “a pick-up in growth in household disposable income and a stabilisation of the housing market” was dropped. Now he warns that sustained weak income growth continues to weigh on consumer spending).

5. Employment has continued to grow strongly and labour force participation is at a record high. The unemployment rate has, however, remained steady at around 5¼ per cent over recent months. Forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate. Wages growth remains subdued and there is little upward pressure at present, with increased labour demand being met by more supply. Caps on wages growth are also affecting public-sector pay outcomes across the country. A further gradual lift in wages growth would be a welcome development. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.

(The employment picture hasn’t changed much from last month, but with the unemployment rate hitting a 12-month high of 5.3 per cent, it’s a long way from the RBA’s estimate of the non-inflation accelerating of unemployment (NAIRU) which it says is around 4.5 per cent. Moreover, the warning of slowing employment growth is an added headwind.).

6. Inflation pressures remain subdued and this is likely to be the case for some time yet. In both headline and underlying terms, inflation is expected to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

(Similarly, the inflation picture hasn’t changed much either, but it’s too low. The RBA pushed out its inflation forecasts in August to show CPI just scraping the bottom of its 2-3 per cent target band by the end of 2021. The persistent undershoot of its target justifies rate cuts).

7. There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne. In contrast, new dwelling activity has weakened and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.

(And despite another strong rise in CoreLogic’s house price data for September, which has backed the RBA’s claim of a “turnaround in established markets”, it was mostly driven by Sydney and Melbourne. More importantly, housing credit growth shrank further in August).

8. The Board took the decision to lower interest rates further today to support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target. The economy still has spare capacity and lower interest rates will help make inroads into that. The Board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes.

(As with the past two cuts, the RBA highlighted its primary aims of supporting growth in jobs to lift income growth and get inflation back up to target, noting that the economy “still has spare capacity.” But it also made it crystal clear that it’s been caught up in the global “race to the bottom”, so that if it didn’t cut again it would push up the dollar, crimping economic growth and inflation).

9. It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

(Significantly, the crucial final paragraph repeated that an extended period of low rates will be required to not only “make progress in reducing unemployment” as was said previously, but to also “reach” its “full employment” mandate and “achieve” rather than “make more assured progress towards” its inflation target. The RBA also removed some conditionality from future potential easing by changing from “is prepared to” ease monetary policy further to “and ease monetary policy further” if needed to reach its employment and inflation goals. The RBA is widely expected to cut the cash rate to 0.5 per cent by May 2020).