INSIGHT: Low Inflation May Trigger Further RBA Cut If Needed

-RBA Hopes Narrowing Rate Differential Eases Pressure On AUD
-Low Rate Aimed At Boosting Household Cashflow, Stronger Growth

By Sophia Rodrigues

SYDNEY (MNI) – The Reserve Bank of Australia’s cash rate cut Tuesday was driven by low inflation and the bank’s view that risks to the housing market from reduced rates were diminishing. The cut may also have another objective – it could reduce the differential between the domestic cash rate and interest rates in other countries that has put upward pressure on the exchange rate.

If the factors behind Tuesday’s cut continue and the exchange rate remains elevated, the RBA remains open to lowering the cash rate further. Whether it cuts as early as November will depend on the inflation and growth forecasts it presents in the quarterly Statement on Monetary Policy due Friday.

At the board meeting Tuesday, the inflation-targeting central bank used the room that its 1.75% cash rate allowed to lower it by 25 basis points to a new record low of 1.5%.

The RBA may be hoping that upward pressure on the exchange rate will ease as the interest rate gap between its cash rate and interest rates in other major economies narrows.

Consumer price index inflation data for the second quarter published last week showed headline inflation rose 1.0% y/y, the slowest pace in the seven quarters that the rate has stayed below the RBA’s 2% to 3% target band. While the more important underlying inflation rose in line with the RBA’s forecast, the bank didn’t change its outlook for inflation to remain quite low for some time.

Although growth in some areas of the domestic economy is running at or above trend, the RBA’s outlook for the economy as a whole is for a moderate pace of growth. As for employment, the bank’s view is that while the modest pace of expansion is expected to continue, that is unlikely to bring down the unemployment rate as fast as is necessary to put upward pressure on wage growth.

Subdued wage growth along with low cost pressures elsewhere in the world are key reasons why the RBA expects inflation to remain quite low.

A rate cut was therefore seen necessary to provide more of a boost to the economy by increasing the cash flow of households as their mortgage rates fall further. The RBA expects stronger growth to ultimately help reduce the spare capacity in the labor market.

The exchange rate effect from a lower cash rate is also an important factor strengthening a lower rate argument.

The cut is supported by the RBA’s view that financial stability risks from the housing market have diminished as lending standards have improved and as house price gains are expected to moderate due to an increasing supply of apartments.

"The most recent information suggests that dwelling prices have been rising only moderately over the course of this year, with considerable supply of apartments scheduled to come on stream over the next couple of years, particularly in the eastern capital cities. Growth in lending for housing purposes has slowed a little this year. All this suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished," the RBA said Tuesday.

–MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@mni-news.com

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