RBA Rate Cut Just The Job

Australia | Jun 05 2019

How many more RBA rate cuts ahead? Opinions vary, but it will all depend on a fall in unemployment and subsequent rise in inflation.

-Unemployment the critical factor for RBA
-Regulatory and fiscal measures play their part
-Will further cuts even help?

By Greg Peel

It’s not about a falling housing market, it’s all about jobs, and subsequently inflation.

After a surprisingly weak CPI result for the March quarter the RBA flagged a rate cut ahead. The only point of debate was whether it would be as soon as May, but given the election in May, June seemed more likely, and so it has come to pass.

A falling housing market and the possibility of increased mortgage defaults seemed like justification to cut the cash rate to stem the tide, but yesterday the RBA statement noted, in relation to housing, “Conditions remained soft, although in some markets the rate of price decline has slowed and auction clearance rates have increased”.

This graph tells the tale:

The housing market is far from irrelevant, nevertheless. The graph is signalling a bottom in house price declines is possibly not far off, and that’s before APRA formerly lowers its mortgage serviceability rate requirement and yesterday’s announced mortgage rate cuts from the banks have their impact.

The main issue with falling housing prices is not as much of mortgage default risk as it is of the “wealth effect”. Even though a mortgaged homeowner may have no desire or need to sell into a falling market, the usual response is to hold off on discretionary spending. In rising housing markets people feel “rich” and go out spending. In falling housing markets the opposite is true.

And that keeps a lid on consumer price inflation. But the signs are improving for the housing market, yet the RBA saw reason to cut. While the board gave a nod to the risks inherent in an all-out global trade war, the primary concern is weak wage growth, which is the result of so-called “spare capacity” in the labour market.

While a 5% unemployment rate was once considered “full employment”, in today’s world that “neutral” rate is lower. The RBA wants to see the unemployment rate fall. And it wants to see the underemployment rate fall. A lot of the “spare capacity” is down to those with part-time jobs wanting either full-time jobs or at least more hours.

A reduction of that spare capacity is required to lift wage growth. Growing wages allow workers to spend, and spending supports higher inflation. The RBA cut its cash rate to an historical low 1.25% yesterday with the specific intention of reducing unemployment. This is the remaining weak factor in an economic outlook that hasn’t otherwise much changed.

Will it work? Clearly few economists believe so. For starters, rate cuts take many months to flow through the system and have their impact. The RBA remains hopeful, but recent labour market indicators suggest otherwise. Consensus has it that a second cut as early as next month would be forthcoming but for a lack of data in the lead-up, and the RBA has suggested in not so many words it is now data-dependent.

As I write, Australia’s March quarter GDP result has just come in at 0.4% growth, slightly below consensus expectation, but 1.8% annual growth, in line with expectation. That’s the slowest annual rate since the GFC.

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