Why the RBA should not cut rates right now

Reserve Bank governor Philip Lowe. Picture: AAP

If the Reserve Bank is thinking of cutting interest rates, which it began to hint at in last month’s minutes, today is not the time to do it.

The bank has held rates steady at 1.5 per cent since August 2016 and can easily postpone any rate cut until later in the year.

Fuelling the expectations of a rate cut has been the unexpectedly low March quarter inflation figures, showing that the official cost of living fell to 1.3 per cent in the first three months of the year compared with the first quarter of last year — down from 1.8 per cent during 2018. This means the CPI has not only been persistently below the bank’s official target range of 2-3 per cent for some time, it is moving even further out of the official target range.

The minutes of the last meeting on April 2 confirm that the board had started talking about lowering rates: “Members agreed that inflation was likely to remain low for some time,” the minutes show. “Wages growth had remained low, there continues to be strong competition in the retail sector and governments had been working to ease cost of living ­pressures.

“In these circumstances, members agreed that the likelihood of a scenario where the cash rate would need to be increased in the near term was low.”

Board members then went on to outline a situation where they could be prepared to consider a rate cut.

“Members also discussed the scenario where inflation did not move any higher and unemployment trended up, noting that a decrease in the cash rate would likely be appropriate in these circumstances,” the minutes said.

“A lower level of interest rates could be expected to support the economy through the depreciation of the exchange rate and by reducing required interest payments on borrowing, freeing up cash for other expenditure.”

What has happened since those words were written is that inflation has come in at a rate lower than expected.

These are very clear-cut comments outlining the circumstances of a future interest rate cut, but taking the board at its word, it would still need to see ­rising unemployment as a trigger for a move. The combination of the minutes and the unexpectedly low March quarter CPI has set the hares running in terms of speculation about a rate cut as early as today.

Westpac chief economist Bill Evans is now expecting two rate cuts of 25 basis points over the course of the year, but more likely not until August, when more data would be available.

The central bank is expected to revise downward its official growth expectation in its statement of monetary policy to be released on Friday. Internationally, the picture is still mixed.

The International Monetary Fund recently downgraded its world growth forecast from 3.6 per cent in 2018 to 3.3 per cent this year. The news out of China in recent months reports an economy that looks to be a bit better than expected thanks to government stimulus measures.

But now US President Donald Trump looks again to have thrown a spanner in the works with yesterday’s tweet that he was prepared to slap more tariffs on Chinese exports if the US could not finalise negotiations on a trade deal soon.

But the main reason not to move today is that any cut during an election campaign would be seen as political, playing into a tightly contested election.

A rate cut could be seen as giving a stimulus to the economy, which could be seen as a positive for the government.

But it could also be seen as a sign the central bank is concerned about the state of the economy, which could easily be spun by the opposition as a negative for the government.

Australia has lived with a steady cash rate for some time while the banks have moved their housing rates on both floating and fixed rates, as well as their fixed-term deposit rates, to finetune their own portfolios.

And as acting National Australia Bank chief executive Phil Chronican has argued, the lower the actual cash rate, the less impact another 25-basis-point rate cut can have on the real economy.

Rather than cut rates, one could argue that the bank’s official target range of 2-3 per cent is outdated given that the world is now living in a different era of low levels of official inflation.

The bank has been happy that the lower exchange rate has helped to stimulate the economy in recent, more uncertain times.

The exchange rate could fall even further on the election of a Labor government — with no change in the cash rate — if international markets assess a Shorten Labor government is less favourable for business than the Morrison Coalition government.

There is no urgent reason for the bank to cut rates today.

But the main reason not to move would be to preserve the bank’s hard won and important reputation for independence.

Staying above the political fray and being seen to do so is ­important.