Get set for an August interest rate cut

Get set for a further interest rate cut on 2 August, which is the date of the next meeting of the Board of the Reserve Bank of Australia.

With the economy expanding at a moderate pace, at best, with the unemployment rate appearing to edge up and global economic conditions only fair, the case for a 25 basis point rate cut, to a fresh record low of 1.5 per cent, is solid.

It will, nonetheless, be the inflation data next Wednesday that will help to lock in the case for lower rates.

Based on available information, inflation is set to rise by 0.8 per cent in the June quarter, which will leave annual inflation at 1.4 per cent.

During the June quarter, there was a sharp lift in petrol prices driven by the jump in global oil prices.

Also read: RBA shrugs off Brexit, rate cuts loom

This alone will account for around 0.25 percentage points of the 0.8 per cent inflation rate.

The high inflation rate for the quarter (0.8 per cent equals annualised inflation around 3.25 per cent) would seem high enough to prevent the RBA from cutting.

After all, the RBA acts with its interest rate settings to keep inflation between 2 and 3 per cent and a 0.8 per cent quarterly rise might be considered the start of a worrying uptick in price pressures.

Fortunately for the economy and jobs, the RBA uses its estimate of underlying inflation and not just headline inflation to determine inflation pressures and based on that, what the appropriate level for official interest rates should be.

If petrol prices are stripped out of the June quarter headline inflation rate, quarterly underlying inflation will be close to 0.6 per cent and in annual terms, just 1.7 per cent which is below the bottom of the RBA target range.

With oil and therefore petrol prices flat in the last month or so, it is unlikely that there will be a similarly high inflation reading in the next quarter based on trends in petrol.

Add to that benign inflation outlook is an economic growth performance that in recent months has seen retail sales growth stall, new dwelling approvals top out and the business investment climate remain weak and the case for a big more of a policy heart-starter for the economy seems compelling.

A further interest rate cut will see official interest rates at a never before seen 1.5 per cent.

Variable mortgage interest rates, which are already below 4 per cent in some instances, will be cut further which will free up cash flows for those with existing debt and lower borrowing costs for those looking to enter the market.

Also read: Turnbull, Morrison meet with RBA head

Before the global financial crisis, it was just about impossible to contemplate Australian interest rates falling to 1.5 per cent or less, as some forecasters are now speculating.

Bit so too were ideas of negative interest rates which are now dominating much of the indistrialised world.

Weak growth, disinflation and high unemployment remain ugly aspects of any economy. Since the GFC unleashed these problems, policy makers have been trying to reverse these problems.

The success has been markedly better the policy response in the 1930s Great Depression even though economic conditions are generally sluggish.

The RBA is part of the super stimulatory policy framework and another rate cut would net week would be a further step in that direction.

 

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks, and as economic advisor to the Prime Minister of Australia.