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RBA Will be Forced to Cut Interest Rates

The data is out, and it is rather compelling. The Australian economy is losing momentum and the risk is that it will weaken further. Not only has there been recent confirmation of a per capita GDP recession – that is, on a per person basis the economy has been shrinking for two straight quarters – but inflation is embedded below 2%, wages growth is floundering just above 2%, house prices are dropping at 1% per month and dwelling construction is in free-fall. Adding to this cocktail of economic woe there is an unambiguous slide in global economic conditions, general pessimism for both consumers and business alike and a worrying decrease in the number of job -advertisements all of which spells economic trouble.

Everyone can see that there is an urgent need for policy action and the sooner the better. For the Reserve Bank of Australia, there is no need to wait for yet more information on the economy. It’s expectations of a growth pick up over the past year have not eventuated.Instead, GDP has all but stalled meaning that inflation, which is already well below the RBA’s target, is likely to fall further.

Will a cash rate cut pump air into our deflating house prices?

The short answer is, no. It is not like a 25 basis point interest rate cut on 2 April and another 25, in say May or June, will reignite inflation and pump air into a house price bubble. Such a claim would be laughable. On the contrary, inflation is so low that at best, it might touch 2% or 2.25% in a year or so and the decline in house prices might slow to 0.5 % per month even if official interest rates were slashed to 0.5%, some 100 basis points below where they are today.

What would a cash rate cut do?

Any interest rate cut would almost inevitably see the Aussie dollar fall, helping the export sector to grow. Free money, in other words, to our export sector from an easing in monetary policy. It would also free up cash flow for the business sector, which has a little under $1 trillion of debt meaning it would be easier to service its collective debt with lower interest rates.

Then there is the fragile consumer. With around $1.3 trillion of debt, a 0.5% reduction in interest costs would save around $6.5 billion a year, money that could be used to reduce debt (which is good) or be spent in the economy (also good).

The impact is more than the rumoured size of the income tax cuts that the Treasurer Josh Frybenberg, will announce in the budget, coincidently on the same day the RBA Board next meets.

Unlike the income tax cuts, which either add to the budget deficit or reduce the budget surplus, interest rate cuts are free!

The stroke of a pen and the press of a few keys on a key board is all it takes to get this stimulus into the economy. This would see firms making more money, consumers having more cash in their pockets and the incentive to hire more workers and pay them more would be raised. An interest rate cut would actually improve the budget bottom line because of the stimulus they give to spending, inflation and tax revenue.

In our opinion, it’s a no-brainer. So for the RBA Board, there is not that much to think about. Cut interest rates on 2 April and again quickly thereafter and sit back and watch the positive effects of those moves flow through the economy. Things will not improve overnight. But like the first tablet in a 5-day course of medicine, it will start to heal the otherwise unwell economy.

The views and opinions expressed in this blog are those of the author and do not necessarily reflect the official policy or position of any other agency, organisation or company. Assumptions made in the analysis are not reflective of the position of any entity other than the author.

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