Why RBA shouldn’t delay a second interest rate cut

RBA governor Philip Lowe. Picture: AAP

The Reserve Bank should not drag its feet and hold back from cutting interest rates a second time next month.

When RBA governor Philip Lowe rolled out the bank’s first cut in almost three years on June 4, he made it pretty clear it would be doing more heavy lifting.

To be sure, in minutes of the bank’s policy meeting published on Tuesday, RBA board members “agreed that is was more likely than not that a further easing in monetary policy would be appropriate”.

So it’s not a question of if the RBA cuts again, it is really just a matter of when.

As economist Gareth Aird at Commonwealth Bank so aptly said: “The RBA is a dovish as it gets.”

There is a case to wait until the August 6 board meeting as the RBA will have a fresh set of economic forecast to mull over at that point.

But it is more like the RBA will deliver a cut next month, before using what are likely to be further downgrades of its economic forecasts in August to set the scene for more easing before the end of the year, and into 2020.

Standing back to survey the scene, we see a central bank ­confronting the reality of a soft economy, flat inflation, and unemployment nudging higher.

The RBA needs to see the unemployment at 4.5 per cent (5.2 per cent now) or lower to support the idea that inflation will at least turn up and point towards the 2-3 per cent inflation target.

Lowe is sufficiently alarmed that he is sending up a distress flare on the economy, hoping Josh Frydenberg will see them and respond with a plan to lift government spending.

Standing back to survey the scene, we see a central bank ­confronting the reality of a soft economy, flat inflation, and unemployment nudging higher.

“Lower interest rates were not the only policy option available to assist in lowering the rate of unemployment, consistent with the medium-term inflation target,” the RBA’s minutes added.

So far the Treasurer appears more keen to preserve his forecast budget surpluses, even though the economic cycle is demanding he think differently.

The cool, collected outward persona of Lowe masks the inner man that is now moving with conviction to arrest a rise in unemployment as the economy has slowed to its weakest pace in a decade. So waiting until August to top up the June interest cut is ­unlikely. There’s a job to be done, and so far Lowe is working at it solo.

Financial markets have already moved well beyond the July-August debate amid an active discussion over what unorthodox policy measures might be required to support the economy.

CBA, which has long held an optimistic view on the economy, was the latest of the major banks to capitulate and forecast two more cuts this year, taking the cash rate down to a record low 0.75 per cent.

The bank also published a discussion paper on how quantitative easing might manifest if called upon. Many banks have been forced to have this discussion in the past month. The debate is vigorous and the options varied.

So while the RBA is sending up flares, and economists are weighing up options for what would be truly emergency measures to support the economy, Canberra looks to be asleep at the wheel.

Frydenberg has income tax relief in the pipeline, something the RBA would say is badly overdue, and an infrastructure outlook that stretches over the next decade.

That’s all fine, but it fails to see what is happening on the main street now, and the growing urgency for a response. Perhaps most alarmingly of all, the RBA’s head of Financial Stability, Jonathan Kearns, yesterday forecast mortgage arrears “could edge higher for a bit longer”.

While the rising number of failing mortgages don’t currently represent an existential threat to banks or the economy, it’s the trajectory that matters, especially at a time of heightened risk globally.

What keeps Lowe awake at night is the fear of rising unemployment in an economy beset with record household debt.

The first crack in the plaster on this front is rising mortgage arrears, with people finding they’ve borrowed far too much against a backdrop of low wages growth and inflation.

Baby-boomers had high inflation and wages growth to help pay off modest home loans, and are probably still passing on that homespun wisdom of big mort­gages as a road to wealth creation to the next generation.

But the economy has changed massively and recent entrants to the mortgage market, with bigger debts to fry, are now facing a significant grind into the future.

If you ever wondered why everything including the kitchen sink was thrown at the economy to push back the global financial crisis, it was fear of what might come if unemployment rose.

It all helps to explain why the RBA should move with haste and cut again in July, before pondering its next move in August.

Dow Jones Newswires