RBA primed to ‘go big’ on rate cuts despite election

The Reserve Bank could roll out as many as four interest rate cuts by year end.

A cut at the RBA’s May 7 board meeting would be controversial. Picture: AAP

The Reserve Bank could roll out as many as four interest rate cuts by year end, with the first coming ahead of the May 18 election, after data yesterday showed inflation flatlining in the first three months of the year.

Coming on the back of a sharp drop in GDP growth in the second half of 2018, sharp falls in house prices, and a slowdown in the global economy, the stage is set for the RBA to cut interest rates at its board meeting next month, its first cut since August 2016.

Don’t expect the RBA to be timid about the next down leg in interest rates.

The RBA board discussed the merits of cutting rates at its April 2 policy meeting, and decided to sit pat, awaiting more data.

Part of the bank’s caution has been due to its realisation that cuts to interest rates would need to be bigger than usual, given high household debt and falling house prices meant that fewer, cautious cuts would have little effect.

The minutes said the bank “recognised that the effect on the economy of lower interest rates could be expected to be smaller than in the past, given the high level of household debt and the adjustment that was occurring in housing markets”.

So the RBA is going to go big. Frankly, it would be silly for the RBA to cut the cash rate once, and wait.

The coming cuts will take the cash rate from its current record low of 1.5 per cent to well below 1 per cent, and to levels that will prompt the RBA to even talk about the potential for balance sheet expansion, should economic conditions turn nasty.

The RBA is facing up to the reality that a review of its economic forecasts on May 10 will include cuts to both its GDP growth and inflation forecasts, sharply eroding any optimism it might retain about the economic outlook.

Still, the impact on variable mortgage interest rates should be swift, as significant falls in wholesale funding costs over recent months would give banks little option but to pass the cuts on in full.

“The RBA would get full bang for its buck,” said Su-Lin Ong, chief economist at RBC Capital Markets.

The RBA is now in danger of undermining its inflation target, which has been the benchmark for interest rate setting since the early 1990s, helping to bring about nearly 30 years without recession.

“The longer inflation undershoots the 2-3 per cent target, the greater the risk that the target will lose credibility. This in turn will see low inflation expectations become more entrenched. making it in turn even harder to get inflation back to target,” said Shane Oliver, chief economist at AMP Capital.

If the RBA defies what is now confident market pricing for an interest-rate cut in May or June, the argument will run along the lines that the unemployment rate remains low and the world growth outlook looks likely to improve in the second half of 2019.

The RBA is also upbeat about a renewed upswing in resources sector investment, and is confident the outlook for exports is buoyant.

So there is some chance the RBA will ride out the drop in inflation and growth, hanging its hat on the job market and signs that firms remain happy to hire.

After all, the unemployment rate in NSW — the most populous state — is at the same level last seen in the 1970s.

A cut at the RBA’s May 7 board meeting would be controversial given that the country is in the midst of an election campaign. It would be the RBA’s preferred option to avoid political entanglements.

It’s hard to know how that would all play out. A drop in ­interest rates could stir up concerns about the economy, working against the Morrison government, and building support for Labor.

Equally, it could calm fears about falling house prices and lift consumer sentiment, working in favour of the Coalition.

Australia’s economy is far from being in a diabolic state, and there is an argument that all the current gloom is built on temporary factors such as falling house prices.

But it will be very difficult for the RBA to remain deaf to the market when annualised GDP growth in the second half of 2018 slowed to about 1 per cent, while core inflation is at record lows.

The levee looks set to break on interest rates in Australia and, once the decision is taken, the RBA won’t walk softly.

The Wall Street Journal