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The RBA will almost certainly be forced to cut interest rates on Tuesday to fight the coronavirus outbreak – but it might not change a thing

Jack Derwin
  • Markets appear to have flipped and are now pricing in a rate cut in Australia on Tuesday.
  • After the US Federal Reserve indicated it may also cut, and the coronavirus tore through markets last week, economists revised their forecasts.
  • However, there remain concerns that another rate cut may not be the kind of stimulus the Australian economy needs.
  • Visit Business Insider Australia’s homepage for more stories.

The global economy looks like it is in the middle of a mighty sneeze.

As coronavirus' spread continues unabated, economists and markets are now expecting central banks to unleash a new round of monetary stimulus and slash interest rates.

On Saturday, the world's most influential, the US Federal Reserve, tried to soothe markets, with chairman Jerome Powell foreshadowing more cuts were on the way. In doing so, the Fed set the scene for his Australian counterpart, the Reserve Bank of Australia (RBA), to do the same when its board meets on Tuesday.

"Yesterday I thought the probability of an RBA cut [on] Tuesday was close to 50% – market was 17%," AMP Capital chief economist Shane Oliver tweeted. "Powell's signalling of a rate cut soon – on top of sharp share market falls with associated loss of wealth – has pushed the probability of a cut on Tuesday to 70% in my view. RBA won't want a higher Australian dollar."

Oliver isn't alone in thinking the RBA will cut.

An uncontained coronavirus threatens to spook markets further and exacerbate existing economic weakness around the world. Its short term impact in China already appears apparent, cannonballing Chinese manufacturing PMI data – a lead indicator of its the country's output – with a PMI score below 50 demonstrating a contraction. In February, it fell from 50 to 35.7, as major factories in Wuhan shut down.

The dramatic fall for Australia's largest trading partner will no doubt be a major talking point at the RBA meeting on Tuesday and has the market now almost certain the board will decide to cut. A 0.25% cut would take the official interest rate to just 0.5% with little room to lower it further to shelter Australia from any further economic shocks.

There are at least two factors working against it. One, the reality that that rate cuts are less effective the closer the official interest rate gets to 0, and two, the fact the RBA has long been concerned current cuts are doing little to stimulate spending.

"Monetary policy could be pushed to the brink by COVID-19, but not convinced it would be the correct policy response nor one that would be overly effective near term," IFM Investors economist Alex Joiner tweeted. "This is likely one of the worst scenarios for the RBA medium term, being forced to ease due to an exogenous shock and risk having those settings underpin and entrenched by a runaway property market and rising household debt."

While those concerns alone will not prevent the RBA from cutting on Tuesday, it could mean it is finally time for the federal government to step up with its own stimulus measures, as recession fears emerge.

"Monetary policy alone can't stop a recession. Fiscal policy might. Increase Newstart, pull forward tax cuts, put in place emergency help for businesses directly harmed," Indeed Asia-Pacific economist Callam Pickering tweeted. "It'd be horrible if great businesses that will once again be viable in May or June, collapse because of demand and supply disruptions in February and March."

While Treasurer Josh Frydenberg has long rejected calls for the government to loosen the purse strings, including the pleas of RBA Governor Phillip Lowe, the Coalition's precious budget surplus looks increasingly like a pipe dream. Budget figures released on Friday indicated the government's bottom line blew out by $3.7 billion in January alone and has seen the government begin changing its tune as it acknowledges the virus could become a pandemic.

"It is a health crisis with very significant economic implications," Morrison told media on Thursday, stating stimulus "measures would only be effective if they were targeted, modest and scalable."

Morrison did not reveal any details of what that stimulus would look like, but did emphasis that the tourism, education, and marine sectors, as well as supply chains and exports, were particularly at risk.

What is clear is the government can't simply rely on the RBA to do all the heavy lifting anymore.