Cash rate slashed to new low

In minutes released from last month’s board meeting – in which the RBA dropped the cash rate for the first time in almost two years – the central bank acknowledged that further cuts to the cash rate were “more likely than not”, with governor Philip Lowe also conceding that the market was not “making any inroads into the economy's spare capacity”.

In his statement this month, Mr Lowe said: “This easing of monetary policy will support employment growth and provide greater confidence that inflation will be consistent with the medium-term target.”

While he said that the outlook for the global economy remains “reasonable”, he noted that “the uncertainty generated by the trade and technology disputes is affecting investment and means that the risks to the global economy are tilted to the downside”.

“In most advanced economies, inflation remains subdued, unemployment rates are low and wages growth has picked up,” he said.

Mr Lowe also noted that conditions in most housing markets remain “soft”, but did highlight that there are “some tentative signs that prices are now stabilising in Sydney and Melbourne”.

“Growth in housing credit has also stabilised recently. Demand for credit by investors continues to be subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality,” he said.

Broader economic factors

Looking at the economy more generally, Mr Lowe commented: “Global financial conditions remain accommodative. The persistent downside risks to the global economy combined with subdued inflation have led to expectations of easing of monetary policy by the major central banks.

“Long-term government bond yields have declined further and are at record lows in a number of countries, including Australia. Bank funding costs in Australia have also declined, with money-market spreads having fully reversed the increases that took place last year. Borrowing rates for both businesses and households are at historically low levels. The Australian dollar is at the low end of its narrow range of recent times.”

The RBA governor noted that the Australian economy grew at a below-trend 1.8 per cent over the year to the March quarter, with consumption growth also “subdued” and “weighed down by a protracted period of low income growth and declining housing prices”.

“The central scenario for the Australian economy remains reasonable, with growth around trend expected,” Mr Lowe said on Tuesday.

“The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in growth in household disposable income is expected to support spending.”

According to the RBA, the labour market outcomes of strong employment growth and labour force participation (along with high vacancy rates) suggest that the Australian economy can sustain lower rates of unemployment and underemployment, although there has been “little inroad” into the spare capacity in the labour market recently, with the unemployment rate having risen slightly to 5.2 per cent.

Mr Lowe said that a further gradual lift in wages growth is still expected and “would be a welcome development”. 

“Today’s decision to lower the cash rate will help make further inroads into the spare capacity in the economy,” he said. 

“It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target.

“The board will continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy and the achievement of the inflation target over time.”

More rate cuts to come?

Severl market observers have predicted back-to-back rate cuts in July and August, as part of an aggressive strategy to stimulate the labour market and boost GDP growth.   

ANZ Research’s head of economics, David Plank, had said: “[Clearly] there is a very real chance the cash rate is cut in both July and August given the RBA’s assessment that ‘we are not making any inroads into the economy’s spare capacity’.”

AMP Capital’s chief economist, Shane Oliver, who also predicted cuts in both July and August, stated that the RBA could lower rates by a cumulative 2 per cent.

“We remain of the view the RBA will [cut] in July/August, November and February, taking the cash rate to 0.5 per cent,” he predicted.

However, governor Lowe has noted the RBA’s reluctance to exhaust its monetary policy tool by dropping the cash rate to a “dangerous low”.

Expected rate cuts from the Federal Reserve in the United States and from the European Central Bank have been flagged as a potential catalyst for a revision to the RBA’s monetary policy strategy.

Analysts have observed that rate reductions from foreign central banks may undermine the RBA’s hopes for a lower Australian dollar to improve the domestic labour market’s competitiveness in the global arena, prompting it to ease further.

In a panel discussion hosted by the ANU Crawford Australia Leadership Forum, governor Lowe acknowledged the challenges but said the central bank would not look to out-cut its foreign counterparts.

“If everyone’s easing, the effect that we get from exchange rate depreciation [isn’t there], so we don’t get the same stimulus that you would normally expect from monetary easing,” he said.

“It may be possible if you ease more than others, but that’s quite a dangerous path to go down.”

He added: “There are limits on what further monetary policy can achieve.”

Mr Lowe renewed his call for alternative policy measures to stimulate the domestic economy.  

“In my mind, that means we need to focus on fiscal policy and structural reforms,” he said.

Attention shifts to mortgage market

The RBA’s June cash rate announcement prompted an immediate response from the market, with several lenders, including the big four banks, passing on the reduction to their mortgage customers.

However, despite warnings from both governor Lowe and Commonwealth Treasurer Josh Frydenberg, some lenders opted not to pass on the cut in full, citing margin pressures and considerations for deposit customers.

Ahead of the RBA’s July board meeting, Mr Frydenberg renewed his call for full 25bps mortgage rate reductions.  

“[We] do expect the banks to pass on in full to the Australian people the benefits of sustained reduction in their funding costs,” Mr Frydenberg told the media.

However, CoreLogic’s research analyst, Cameron Kusher, has said that lenders would look to protect their savings customers and ease margin pressures.

“Our expectation is that banks will be holding back on passing on the full cut as they seek to balance out mortgage rates with deposit rates and protect net interest margins,” he said.

The Australian Prudential Regulation Authority’s latest quarterly ADI institution performance statistics revealed that the collective net profit after tax of Australia’s banks fell by 12.6 per cent ($1 billion), from $8.31 billion in the March quarter of 2018 to $7.26 billion in the March quarter of 2019.

When assessed on an annual basis, the collective net profit after tax of Australia’s ADIs dropped by 4.1 per cent ($1.6 billion), from $36.1 billion in the 12 months ending 31 March 2018 to $34.5 billion in the 12 months ending 31 March 2019.

[Related: Brokers expect at least one more RBA cut]