Australian Financial Review
Reserve Bank governor Philip Lowe has set up financial markets to expect a further easing bias to 1 per cent suggesting the only way the bank can achieve employment growth and inflation targets is through cutting rates.
Dr Lowe said the bank’s decision to cut rates to an historic low of 1.25 per cent from 1.5 per cent had been driven by a failure to see enough wage growth and inflation, and not because of a deterioration in the economic outlook since the bank last met.
“Are interest rates going to be reduced further? The answer here is that the board has not yet made a decision, but it is not unreasonable to expect a lower cash rate,” Dr Lowe said.
“Our latest set of forecasts were prepared on the assumption that the cash rate would follow the path implied by market pricing, which was for the cash rate to be around 1 per cent by the end of the year,” Dr Lowe said.
However, the bank’s forecast for the unemployment rate this year is 5 per cent, lower than the current rate of 5.2 per cent, automatically implying that rates would need to be cut to achieve that.
The central reason for the cut he said was to stimulate wage growth through a further reduction of the unemployment rate.
“I want to emphasise that the decision is not in response to a deterioration in our economic outlook since the previous update was published in early May.”
Dr Lowe said given the combination of the labour market and inflation outcomes of late, the bank’s judgement was that it could sustain an unemployment rate of “4 point something” a reduction from the current 5.2 per cent.
“It is possible that the current policy settings will be enough – that we just need to be patient. But it is also possible that the current policy settings will leave us short,” Dr Lowe said.
“Given this, the possibility of lower interest rates remains on the table.”
“Monetary policy does have an important role to play and we have the capacity to play that role if needed.”
Several economists have forecast that rates could be cut to as low as 0.5 per cent by this time next year because the effort needed to return inflation to its target was taking more time.
“Inflation is still expected to increase, but it is unlikely to be comfortably within the 2–3 per cent range for some time yet,” Dr Lowe said, “So the progress on returning inflation to target is more gradual than we had hoped.”
He said if inflation stays too low for too long, it was possible that inflation expectations would move lower – “that Australians come to expect sub-2 per cent inflation on an ongoing basis.”
“If this were to happen, it would be harder to achieve the medium-term inflation goal. So we need to guard against this possibility.”
Dr Lowe also started a skirmish between the banks and politicians suggesting there was no excuse for banks not to pass on the rate cut in full.
“This reduction in the cash rate should be fully passed through to variable mortgage rates,” Dr Lowe said.
Article appeared in The Australian Financial Review on 5 June 2019.
Article written by Matthew Cranston.