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The RBA cut its official interest rate today, as expected – from 1.5%, to a record low of 1.25%. This marks the first change in interest rates since August 2016 – the longest run of stable rates on record.
As recently as February, the RBA had ruminated that the next change in interest rates would likely be up, eventually, not down. But since then, it has become clear that the economy has not been in a position of strength. Data has confirmed that Australia’s economic growth slowed sharply in the second half of 2018, and also that inflation has fallen further below the RBA’s target of 2–3% (see chart). The labour market has remained healthy, but the unemployment rate has stopped falling (and even ticked up last month as more people entered the jobs market), while the rate of under-employment remains relatively high.
With low inflation, low economic growth and few signs that the jobs market is tight enough to push wage growth up, the RBA has acted. In its own words, ‘Employment growth has been strong over the past year, labour force participation has been increasing, the vacancy rate remains high and there are reports of skills shortages in some areas. Despite these developments, there has been little further inroads into the spare capacity in the labour market of late. The unemployment rate had been steady at around 5 per cent for some months, but ticked up to 5.2 per cent in April.’
In other words, the RBA wants to boost job growth, get unemployment down further and spark some upward pressure on wages. That would help push inflation back up to the RBA’s target.
The RBA will be hoping that indebted households will spend more as their cash flow improves, and that exporters and import-competing businesses will benefit from a lower Aussie dollar. That would help strengthen the economy and strengthen inflation. The housing market, which is currently in the doldrums, may fare a bit better with interest rate cuts too. Indeed, there have already been signs of bottoming out in the housing market, with price falls slowing and auction results improving. Most recently, major banks have reported a pick-up in mortgage enquiries. Recent changes to APRA lending rules, and a planned government guarantee for some first home buyers, could also increase demand from some buyers. Lower interest rates might be a further bit of good news that stops the housing market sinking much further.
After today’s rate cut, more are certainly possible. While there were few hints in the RBA’s statement about anything further, financial markets have fully priced in a second 25 basis point cut by October, with a chance of a yet another cut beyond that.
The central bank will certainly continue to keep a close eye on jobs data over coming months as it weighs up whether to cut rates again.
David is a macro economist with extensive experience in applied economic and quantitative analysis of the Australian economy, along with considerable experience in labor market analysis. David is a regular commentator on macroeconomic trends, and prepares a weekly economic briefing newsletter.