With a succession of rate cuts expected over the coming months, the RBA may be forced to consider controversial ways of driving growth back into the Australian economy.
Following the Reserve Bank’s decision to reduce the cash rate by 25 basis points on Tuesday, which came as no surprise to the market, AMP Capital chief economist Shane Oliver joined a chorus of forecasters betting that more rate cuts will be needed to stimulate growth.
While lower rates will be welcome news for borrowers, the reality of what they mean for the broader economy is far more concerning story.
“Economic growth has slowed sharply below its long-term potential reflecting the housing downturn, but other factors from drought to the threat to global growth from the US trade wars cloud the outlook,” Mr Oliver said.
“This in turn has seen the outlook for unemployment deteriorate – at a time when there is still a high combined level of unemployed and underemployed (at 13.7 per cent of the workforce). Which in turn threatens to keep wages growth,” he said. “Which in turn threatens to keep wages growth low and inflation below the RBA’s 2-3 per cent inflation target for even longer.”
Mr Oliver highlighted that the RBA has revised down sharply its growth and inflation forecasts over the past six months and now doesn’t see inflation rising above 2 per cent out to 2021, even with the technical assumption of two rate cuts.
AMP Capital recently changed its cash rate forecast in light of a deteriorating global economic outlook and weaker than expected economic data. The economy is now growing at an annual rate of 1.8 per cent, the lowest in 10 years.
Mr Oliver said he expects another 0.25 of a percentage point rate cut in July or August and two more rate cuts by mid next year, taking the cash rate to 0.5 of a percentage point.
“We had thought 1 per cent would mark the low and positive signs regarding residential property prices are helpful in this regard. But the flow of weak economic data and increasing risks to the global outlook with Trump’s trade wars and the slowing jobs market pointing to unemployment rising to 5.5 per cent by year end make it hard to see just two rates cuts being enough, given that the RBA really needs to see unemployment fall to 4 per cent or below to get inflation back to target.”
QE not off the table
The AMP capital chief economist cautioned that as the cash rate falls, we are likely to see an increasing debate around whether the RBA will use quantitative easing.
The practice of using printed money to buy bonds to inject cash into the economy, known as QE, was employed by the US Federal Reserve in three tranches over the last 10 years as the American economy sought alternative monetary policies to pull itself out of one of the biggest economic disasters in history, the global financial crisis of 2008-2009.
“QE is not our base – as we don’t think things are that bad – but as has been the case at other major central banks the RBA is likely to prefer exhausting cash rate cuts before considering QE and this is unlikely until it gets the cash rate down to 0.5 per cent,” Mr Oliver said.
While rates are already at record lows, the prospect of a 0.5 of a percentage point cash rate will have a detrimental impact on Aussie banks, where margins are already being squeezed.
“QE is an option,” Mr Oliver said. “But to the extent that it lowers 10-year bond yields it may not help much in Australia as most household borrowing is on short term rates.
RBA already open to alternative methods
While QE may sound like an extreme solution, the central bank has already showed a willingness to support new and often untested approaches to stabilise the economy.
Macroprudential measures in the form mortgage lending restrictions have been a key feature of the Australian mortgage market in recent years as the Council of Financial Regulators (APRA, ASIC, the Treasury and the Reserve Bank) worked to curtail risk in the housing market.
While unemployment and inflation have dominated the discussion around this week’s rate cut – the first move from the RBA since 2016 – housing and household debt levels remain a major concern for the central bank.
The prudential regulator, which has been cautious about the risks in the mortgage market since it started tightening the screws on lenders back in 2015, eased up its stance last month by easing serviceability requirements. While APRA stated that its actions will likely lead to a greater borrowing capacity for Aussie homebuyers and greater flexibility for banks, the regulator also highlighted that the original risks its policy was intended to mitigate remain.
“APRA introduced this guidance as part of a suite of measures designed to reinforce sound residential lending standards at a time of heightened risk. Although many of those risk factors remain – high house prices, low interest rates, high household debt, and subdued income growth – two more recent developments have led us to review the appropriateness of the interest rate floor,” Mr Byres said.
“With interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid has become quite wide in some cases – possibly unnecessarily so,” he said.
QE flagged in December
Reading these statements, which are in stark contrast to the heavy-handedness APRA has demonstrated towards lenders up until now, it would be fair to assume low rates will remain the norm for some time.
How low the RBA will go to achieve its inflation targets and ward off a spike in unemployment remains to be seen. The official cash rate is now 1.25 per cent. If a few more cuts are made, the Reserve Bank will be forced to address its options., including quantitative easing.
This should come as no surprise to anyone keeping a close eye on the central bank’s rhetoric. Late last year RBA deputy governor Guy Debelle sparked plenty of debate among economists when he stated that the Reserve Bank could use QE to deal with a crisis in financial markets.