RBA Pushes Government to Take Action: Will a Cut to the Cash Rate Fix the Economy?

RBA Pushes Government to Take Action: Will a Cut to the Cash Rate Fix the Economy?

RBA Pushes Government to Take Action

Will a Cut to the Cash Rate Fix the Economy?

A clear request for greater structural change in the economy shone through in Reserve Bank Governor Philip Lowe’s discussion with the Economic Society of Australia in Brisbane yesterday. During the questions session, some firm suggestions to take action were put to Prime Minister Scott Morrison. Lowe’s intense analysis of the health of the economy has led him to a firm conclusion that changes to monetary policy would not be sufficient to resolve the need for more stimulus and economic growth. He noted that the cash rate is already extremely low at just 1.5 percent, thus cannot be cut much further. A major fear is whether any increase in the unemployment rate is on the cards with April’s data showing an increase to 5.2 percent from 4.9 percent earlier in the year. Lowe’s focus was primarily on the need for change to encourage businesses to hire more people, invest more to expand and to foster innovation.

Signs of a cash rate cut in June are more evident than ever with market pricing now factoring in a 70 percent likelihood. A strong consensus has been that the federal election had a strong impact over the decision to keep the cash rate on hold this month due to the fact that either of the major political parties could have manipulated such an announcement to their advantage. The RBA did not want to play political games. As a result, is the likely rate cut in June therefore overdue? Inflation data for the first quarter was at its lowest rate since the third quarter of 2016, falling to just 1.3 percent from an already weak 1.8 percent in the previous quarter last year. University skeptics have been calling the RBA’s target inflation rate of 2-3 percent as a bit of a joke given the lack of action taken. If unemployment continues to rise, a rate cut could be too little too late.

The RBA has explicitly flagged that lower interest rates will be discussed at its upcoming meeting with a rate cut extremely likely. Philip Lowe himself, almost out of character, stated, “A lower cash rate would support employment growth and bring forward the time when inflation is consistent with the target.” But he remains adamant that some issues are not for monetary policy to address. His belief is that the tax system is the ultimate driver of economic growth. The election outcome has made it clear that households prefer stability and continuity. But when considering what’s best for growth in the economy, the RBA is clearly of the opinion that growth is sub-optimal currently.

Scott Morrison has indeed promised some clear tax reform with income tax cuts up to $1,080 offered per person. This positive increase to households’ disposable income provides a key stimulus driver for growth in sectors such as retail. Investors are already responding confidently regarding a projected increase in spending. Major retailers such as JB Hi-Fi and Harvey Norman have seen significant positive gains in the share market, up 4.2 and 5.4 percent respectively. The biggest challenge currently faced however is whether there will be a possible delay to the tax reform. Whilst Morrison has promised that the tax cuts will be delivered during the next financial year, whether those changes will come into effect for FY 2019 becomes increasingly unlikely. As June 30 creeps closer, the Australian Tax Office is lobbying for parliament to change the law sooner or even retrospectively. Lowe has become increasingly critical of the government as the drivers that he predicts will grow the economy do not align well with the Coalition’s actions past and present. Whilst he does not want to give the government advice, he has called out the current tax system for failing to foster growth, something likely tough to muster for Treasurer Josh Frydenberg who has pledged 1.25 million new jobs within the next 5 years.

Monetary policy has historically had a more direct transmission effect on the economy due to it previously having more impact on the interest rate charged on variable home loans. A major transition away from this occured in 2015 when the Australian Prudential Regulation Authority required lenders to incorporate a serviceability buffer of 2 percent above a loan product rate and a minimum rate of 7 percent. When the banks created a serviceability floor rate of 7.25 percent, the customer’s borrowing capacity was effectively capped notwithstanding any changes to the cash rate. A steep decline in home lending saw APRA respond by undoing some of its changes to borrowing constraints. Reversing the serviceability buffer could allow a borrower’s capacity to increase by as much as 14 percent. A lower interest rate combined with more relaxed loan serviceability requirements could result in a 5-10 percent increase in Australian house prices. The stimulatory effect of these changes could be dramatic however higher property prices combined with stagnant incomes should be treated with caution.

By Guy Clarke

Click here for a one month free trial to our Lotus Blue Portal.

KOSEC does not take into account the investment objectives, financial situation and advisory needs of any particular person, nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information provided. KOSEC is intended to provide general information only. Please be aware that investing involves the risk of capital loss. This message is confidential and may be privileged. It is intended only for the use of the addressee named above. If you are not the intended recipient, any unauthorised dissemination, distribution or copying is illegal. We do not guarantee the security or completeness of information hereby transmitted and are not liable in either respect or in respect of any delay. Nothing in this message is intended as an offer or solicitation for the purchase or sale of any financial instrument. Any market prices or data, unless specifically verified and identified as such, are not warranted as to completeness or accuracy. Kodari Securities Pty Ltd (KOSEC) is a Corporate Authorised Representative (No. 399 556) of Longhou Capital Markets (AFSL No. 292464) which is regulated by the Australian Securities and Investment Commission (ASIC). KOSEC wishes to disclose that KOSEC and its staff may hold stock they recommend in their own portfolios and that any decision to purchase recommended stock should be done so after the purchaser has made their own inquires as to the suitability to their own requirements. Click here to view our FSG.
Rate this post

div#stuning-header .dfd-stuning-header-bg-container {background-image: url(https://www.kosec.com.au/wp-content/uploads/2019/01/Dashboard-Blue.png);background-size: cover;background-position: center bottom;background-attachment: initial;background-repeat: no-repeat;}#stuning-header div.page-title-inner {min-height: 335px;}
X