Australia markets close in 4 hours 33 minutes
  • ALL ORDS

    6,899.50
    +44.00 (+0.64%)
     
  • ASX 200

    6,695.10
    +51.00 (+0.77%)
     
  • AUD/USD

    0.7370
    +0.0011 (+0.15%)
     
  • OIL

    44.79
    -0.12 (-0.27%)
     
  • GOLD

    1,805.10
    +0.50 (+0.03%)
     
  • BTC-AUD

    25,923.12
    -32.46 (-0.13%)
     
  • CMC Crypto 200

    377.31
    +7.56 (+2.04%)
     
  • AUD/EUR

    0.6191
    +0.0007 (+0.12%)
     
  • AUD/NZD

    1.0558
    +0.0009 (+0.08%)
     
  • NZX 50

    12,697.96
    +144.58 (+1.15%)
     
  • NASDAQ

    12,079.81
    +173.87 (+1.46%)
     
  • FTSE

    6,432.17
    +98.33 (+1.55%)
     
  • Dow Jones

    30,046.24
    +454.97 (+1.54%)
     
  • DAX

    13,292.44
    +165.47 (+1.26%)
     
  • Hang Seng

    26,588.20
    +102.00 (+0.39%)
     
  • NIKKEI 225

    26,522.16
    +356.57 (+1.36%)
     

Amid fires, disease and chronically low inflation, the RBA does nothing

Stephen Koukoulas
·4-min read
The Australian bushfires and coronavirus outbreak has impacted the economy. (Source: AAP)
The Australian bushfires and coronavirus outbreak has impacted the economy. (Source: AAP)

It’s all but official – the Reserve Bank of Australia has abandoned it inflation target of 2 to 3 per cent and in all likelihood, has ended the interest rate cutting cycle.

The RBA left monetary policy unchanged at its February meeting, despite data last week showing annual underlying inflation remaining at a record low 1.4 per cent, well away from the 2.5 per cent mid-point of the RBA inflation target.

Indeed, underlying inflation has been below the bottom of the RBA target for four years and on present indications, it looks like staying outside that range for a few more years.

It is a massive failure of the RBA to miss its inflation target so badly, for such a long period of time when all along, it could have implemented stimulatory monetary policy to support economic growth and drive inflation higher.

With its inaction this week, the RBA also failed to give some pre-emptive stimulus to the economy, which is unexpectedly facing a wall of negative risks stemming from the bush fires and the coronavirus.

If it didn’t see fit to cut interest rates in these circumstances, it will take a huge economic disaster before it moves.

Greens shoots go up in smoke

To be sure, and as RBA Governor Phillip Lowe mentioned in December, the economy was gaining some much needed strength into the end of 2019. Building approvals, house prices, employment and even retail sales were better than expected.

It is good news and indeed, the stage was set for a strong second half of 2020 and into 2021 if nothing bad came along.

Exports were also strong and business investment was, for the first time in many years, poised for a long awaited pick up.

But since those data were compiled, there has been a slump in both business and consumer confidence, local and global stock markets have been hit hard as fears of the coronavirus have swept around the world and government bond markets have factored in a significantly higher risk of ugly economic conditions in the months ahead.

Inflation has also remained too low.

While it is still too early to be sure, it appears that key commodity prices have fallen sharply which may turn into a problem in the months ahead.

Insurance against a hard landing

Because of all of this, it is not clear why the RBA didn’t take out some economic policy ‘insurance’ with a further easing in monetary policy.

There is zero chance that a 25 or even 50 basis point cut in interest rates would see inflation run out of control.

Indeed, it is problematic how quickly inflation would return to target even if it cut 50 basis points, even though such action would obviously help support growth over the next 6 to 24 months.

It’s not just the RBA. The government should help

Of course, there is more to managing the economy than official interest rates.

The government controls a trillion dollars of tax and spending and it can put in place policies to manage peaks and troughs in the business cycle.

To that end, it is important that the government look at measures to support the economy if some of the negative threats are embedded in the economy.

The budget is still more than three months away (12 May) and action may be needed prior to then.

To its credit, the government has allocated funds to address some of the losses and reconstruction effort as a result of the fires.

If the coronavirus dislocates trade, especially tourism and education, then immediate fiscal stimulus would be necessary.

Such policies could take the form of direct cash payments, further support for the fire ravaged regions and a fast tracking of small infrastructure projects – anything that quickly gets cash into the economy.

In the mean time, the RBA continues to flounder.

The economic scorecard with GDP growth entrenched below trend, with inflation locked in below target, with the labour market, as a result, dogged by high unemployment, higher underemployment ands chronically weak wages growth, is not good.

The last interest rate cut from the RBA was four months ago. It has had a bias to cut interest rates since then but has failed to follow through.

This has been a mistake and the concern in financial markets is now that the economy will be weaker for longer as a direct result of this policy mistake.

Make your money work with Yahoo Finance’s daily newsletter. Sign up here and stay on top of the latest money, property and tech news.