More rate cuts to come as Reserve Bank tries to lower unemployment

RBA Governor Philip Lowe in Darwin on Tuesday night. Amos Aikman/The Australian

The Reserve Bank has been busy rolling out its first back-to-back cuts in interest rates since mid-2012, but the bank’s heavy lifting of the economy isn’t complete.

The half-a-percentage-point cut in its official rate since June 4 is a solid step in the right direction for the economy, which has slowed sharply since midway through last year.

To be sure, the cuts are probably enough to lift business confidence, stabilise falling house prices and get consumers in the mood to spend a little more.

But it won’t be enough to achieve what the RBA has actually set out to do — which is get the unemployment rate down to 4.5 per cent, or lower.

That’s the level of unemployment the RBA thinks will see spare capacity mopped up, trigger higher wage demands and stoke the inflation rate.

RBA governor Philip Lowe has said on a number of occasions the central bank’s own modelling shows that 50 basis points of rate cuts would still return an unemployment rate stuck at around 5 per cent two years from now.

So logic suggests that policymakers are already formulating plans to cut rates further.

They might be more measured from here on, but more interest rate cuts look highly likely.

Many economists argue that interest rate cuts need to extend to one percentage point in total if the RBA wants a lower unemployment rate.

Onlookers might think that achieving the desired level of unemployment is an easy stroll from the current rate of 5.2 per cent.

But think again.

The economy is growing at a pace well below what’s needed to bring down unemployment over time. The bigger risk remains that the jobless rate will rise from here.

Workforce participation has also jumped. As more people look for work, it naturally makes the job of reducing the unemployment rate, and underemployment rate, much harder.

The surge in participation might be seen as a sign of burgeoning confidence, and maybe it is.

But it might also be that there is a scramble to get second incomes because householders are servicing record debts at a time of negligible wages growth.

Wages have been flat for years — and the strain is showing.

Externally, the trade war between the world’s biggest economies, China and the US, has the potential to be devastating. The fight over tariffs and intellectual property looks to be highly political in nature. There is reason to think US President Donald Trump may drag it out.

What multinational firm can confidently draw up investment plans in an environment where viable business models are trampled in the time it takes to tweet?

The trade war doesn’t support a scenario of rapidly falling unemployment in Australia — a massive exporter of resources and deeply reliant on China for its prosperity.

The last time Australia’s unemployment rate approached 4.5 per cent was more than a decade ago.

It’s actually a pretty rare event, more consistent with events like mining booms.

You can be certain that, if the unemployment rate rises, the RBA will be quick on the trigger and deliver a further half a percentage point of interest rate cuts.

Dr Lowe’s worst nightmare is a rising unemployment rate that brings with it rising mortgage delinquencies and trouble for the nation’s banks.

The RBA will publish a new set of economic forecast in August which are likely to include downward revisions to its economic growth outlook. The Statement on Monetary Policy will help frame the case to cut interest rates further, if needed. Any concerted effort by Canberra to bring forward infrastructure spending and lift payments to households might delay the RBA cuts.

But, at the moment, Treasurer Josh Frydenberg appears unlikely to want to delay returning the federal budget to surplus.