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Why an interest rate cut is needed

It has been more than 8 months since the last interest rate cut from the RBA and based on the recent rhetoric from senior officials, it is unlikely to deliver another one in the near term. Over the medium term, the RBA is likely to change its view on the economy and it is likely to cut interest rates as it strives to boost growth, inflation and employment.

In forming this controversial view of monetary policy, the RBA is paying lip service to the bulk of the hard data on the economy, which would normally demand an immediate interest rate cut or two. Instead, the RBA is relying on what are very optimistic forecasts for the economy and is making a proverbial mountain out of a mole hill about house prices pressures in Sydney and Melbourne in deciding not to cut.

Interest rates are only a part of the house price problem in those cities. Simply note weak housing in Perth, Darwin and much of regional Australia to see why the current level of interest rates are not the main factor in the house price equation.

Since the August 2016 interest rate cut, the hard data paint a disconcerting picture on the economy. The unemployment rate has risen from 5.7 per cent to 5.9 per cent; the annual increase in the underlying inflation rate has dropped from 1.6 per cent to 1.5 per cent; annual wages growth has slowed from 2.1 per cent to 1.9 per cent and annual growth in real growth in GDP has dropped from 3.1 per cent to 2.4 per cent. Retail sales and new building approvals have also been very weak since the second half of 2016.

In simple terms, the economy has weakened across this broad range of vitally important indicators with most of the weakening largely unexpected. Had the RBA been reacting to this new news, it would have already cut rates by 25 or even 50 basis points.

To be sure, there has been a little positive news. The RBA index of commodity prices has risen 30 per cent over the last 8 months and business expectations are firm. That said, coal and iron ore prices are off their recent highs.

What’s more, in terms of housing there is clearly a glut of property forming in most cities which sensible analysts suspect with slow the growth in prices and add to the risks in the economy.

What’s more, the banks have been lifting interest rates during this fragile economic climate. The rising cost of funds has been mortgage and business interest rates rise which will, at the margin, act to cool already soft spending and investment.

The economy is not registering sufficient growth to see inflation lift appreciably over the short and medium term. As such, it still seems more likely than not that once the RBA gets its head out of the sand and into the data bases on the economy, it will trim interest rates again.

Two 25 basis point cuts over the next 12 months seems a minimum requirement, with the unemployment rate currently too high and inflation too low.