Interest rates in Australia could be headed as low as 0% as the economy sinks

• As the outlook for the economy worsens, the official interest rate could go as low as 0%, the Reserve Bank of Australia (RBA) has flagged.

• Fronting a parlimentary economics committee, RBA governor Phillip Lowe said all options were on the table as the central bank lowers its short-term forecasts.

• Beyond slashing the interest rate from its current 1%, Lowe said it was starting to run out of ways to stimulate the economy, urging the government to increase spending.

---

The official interest rate is currently at 1% -- its lowest point in history -- but could soon go much lower.

Questioned by the parliamentary economics committee on Friday, Reserve Bank of Australia (RBA) Governor Phillip Lowe suggested it's possible that's where we're headed.

"It's possible we end up at the zero lower bound although I think it's unlikely," Lowe said.

"We are prepared to do unconventional things if the circumstances warranted it," he said. "I hope we can avoid that."

But will he be able to?

The RBA's latest forecasts show the RBA have downgraded their prediction of future Australian growth.

"(That) assumes that the worst of the downturn in the domestic economy has now passed. We think this is too optimistic at a time when global growth continues to slow," AMP Capital senior economist Diana Mousina said in a note.

"While the RBA still expects a rebound in the Australian economy and does not sound as panicked as the Reserve Bank of New Zealand this week -- who surprised markets and cut interest rates by 0.50% -- we think that the weakening in the global environment and a deterioration in the domestic labour market figures will push the RBA to cut interest rates in September, earlier than expected, and another cut in November taking the cash rate to 0.50% by the end of the year."

That expectation from AMP Capital echoes the RBA's newly updated interest rate forecast (above), published to coincide with Lowe's appearance. In it, the central bank currently predicts interest rates could go to 0.25% as inflation drags.

"It is likely to take longer than earlier expected for inflation to return to 2%," it said in its latest statenent.

"Inflation is expected to be a little under 2% over 2020 and a little above 2% over 2021."

That puts the Australian economy on track to miss its growth targets for at least two more years -- a dismal failure for the RBA which is tasked with keeping it above 2%.

To reinvigorate the economy, the RBA needs to get Aussie wages growing and unemployment down from its current level of 5.2%, according to Mousina.

"Ultimately, to get wages growth back to around 3% -- its longer-run normal level -- and underlying inflation at 2.5%, the unemployment rate needs to be at around 4.5%," she said.

"Today’s forecasts from the RBA show that even with a cash rate of 0.5%, the unemployment rate will only get down to 5%, so more stimulus -- monetary or fiscal or both -- will be necessary eventually."

With the government reluctant to blow their projected budget surplus, Lowe may not have a choice but to keep on cutting.