This article was written on 26 August 2019: It was on the Yahoo Finance website at this link 


The RBA should cut interest rates next week

The board of the Reserve Bank of Australia meets next week and the smart money is betting it will not cut interest rates. 

What’s more, the market is anticipating the RBA will not only hold the line this time and probably also in October, but will cut rates at the November Board meeting. This will be after what is expected to be a weak inflation result in late October and perhaps 50 basis points or more of interest rates cuts from the US Federal Reserve in coming months.

By November, the rise in the unemployment rate is likely to be further entrenched which will make the case for lower interest rates a certainty. This may well turn out to be the case, but the scenario outlined above begs a question, why should the RBA wait to give the economy a much needed boost?

No reason to hold off

In other words, why not cut interest rates next week when everyone and their dog knows the economy is currently weak, when inflation is testing record lows and the labour market is starting to deteriorate. Add to this the unfolding dislocation to global trade and economic growth, courtesy of US President Donald Trump and his irresponsible escalation of tariff wars, and there seems no sensible reason for the RBA to hold off cutting interest rates to help guard against these negative influences.

With the RBA mandate to target annual inflation at between 2 and 3 per cent in concert with full employment, if the RBA was to cut 50 basis points next week would it threaten to blow the inflation and full employment targets out of the water?

When asked that way, it is rather silly to think the RBA should wait given inflation has been below 2 per cent for four years and the unemployment rate is rising. Looked at another way, the chances of inflation exceeding 3 per cent and for the unemployment rate to dip below 4.5 per cent (consistent with a very conservative estimate of full employment) even with official rates near zero per cent would seem so close to zero that the RBA might as well cut next week.

Alas, it is not that easy.

Nothing to lose

If the recent tone of comments and research from the RBA is any guide, the ‘rates on hold’ decision would be more likely. There is no doubt that house prices have not only passed the low point but are starting to lift at a solid pace. In August, house prices in Sydney and Melbourne have risen by around 1 per cent, the strongest monthly rise in over two years.

The RBA will not be pleased with this, even though house prices are not part of the RBA mandate. It does consider, against the evidence, that rising house prices lead to greater financial risk and financial instability and if interest rates are too low these risks build.

Which brings us back to the odds of an interest rate cut at next week’s RBA meeting. If it were the basic economic fundamentals of economic growth, inflation and the unemployment rate that determined the decision, the RBA would cut interest rates next week and would do so with gusto.

There is nothing to lose and potentially a lot to gain by giving the faltering economy some more stimulus.

If the RBA gives too much consideration to things that are not directly in its mandate such as house prices and household debt and it maintains upbeat forecasts for the economy one and two years into the future, it will leave rates steady. With an interest rate cut priced into the market a couple of months hence and global events providing a dark cloud to the outlook, the RBA should cut and do its bit to lean against a hard landing for the economy into 2020.