The Reserve Bank’s decision to cut the cut the cash rate for the second month in a row is part of a new found aggressive “going for growth” strategy that aims to drag down the unemployment rate and push up the rate of inflation.
But while seemingly a worthy goal, the RBA will likely find it very tough to meet either objective over the foreseeable future, suggesting even deeper interest rate cuts seem ahead of us. My base case view is that the RBA, rightly or wrongly, will cut the cash rate to 0.5% by February 2020 – though it will now pause at least one or two months to assess the impact of its recent moves.
Upward pressure on the unemployment rate
As evident in the chart below, the deterioration in the NAB Index of hiring intentions over the past year suggests that, far from trending down, the unemployment rate is currently on course to trend up. Given wage growth has remained low at an unemployment rate around 5%, it is unlikely to accelerate – and may well slow again – should the unemployment rate gradually moves back toward 6%. Ongoing trade tensions also risk causing both local and global businesses to delay investment spending plans, which will further undermine the growth outlook.
But the RBA’s efforts may be in vain
The RBA’s goal is to reverse this apparent upward pressure on the unemployment rate as quickly as possible. But given high household debt, and still high Sydney and Melbourne house prices, lower rates seem unlikely to spark a housing and consumer related turnaround anytime soon. Indeed, the most interest-rate sensitive parts of the economy – those that tend to benefit most from lower rates – already seemed “tapped out”.
If so, Australia may well already be in a “liquidity trap” and further deep interest rate cuts would be akin to “pushing on a string”.
The RBA’s goal of boosting inflation more broadly will likely also remain frustrated by ongoing structural disinflationary forces, such a technology, demography and globalisation.
Meanwhile, ever lower interest rates risk creating financial distortions and medium-term risks to financial stability.
In short, due to already tapped out consumers and structural disinflationary forces, deeper interest rate cuts seem unlikely to push up inflation over the foreseeable future, and – to the extent they do – could come at the risk of medium-term financial stability concerns.
Better balanced macro-economic policy required, specifically focused on unemployment rather than inflation per se.
Spare labour market capacity, rather the inflation per se, should be ultimate concern of policy makers – and the former seems better tackled not through lower interest rates but improved labour market policies and more immediate fiscal stimulus.