What’s the outlook for the cash rate?

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It’s been 13 months since the Reserve Bank of Australia (RBA) last changed the current 1.5 per cent cash rate. Consensus among academics suggests there’s little chance of a change to the cash rate any time soon.

While some countries, including the US and Canada, have started to raise interest rates after a period, and it’s understood the UK will soon follow suit, May next year is the earliest that economists expect any change in the cash rate here.

Economist Saul Eslake explains inflation is the main reason why the RBA is sitting on its hands.

“Economic growth is flat and inflation is below the Reserve Bank’s two per cent to three per cent target,” he says. Inflation sat at 1.8 per cent over the June quarter, but Eslake says this figure is predicted to rise.

GDP growth year-on-year for the June quarter was 1.8 per cent, below the 3.47 per cent average. It is forecast to rise to 2.7 per cent for the third quarter.

In its most recent minutes, the RBA says it expects inflation to be 2.0 per cent in the second half of this year.

Higher inflation figures are not enough, however, to prompt a decision to move the cash rate. Unemployment rates on the high side are another reason the RBA has not changed the cash rate.

Unemployment for July sat at 5.6 per cent but Eslake says the RBA would prefer this to be closer to 5.0 per cent.

“The unemployment rate isn’t telling the full story. There’s spare capacity in the labour market as a result of people working fewer hours than they want to. So the central bank would like to see some progress on that front,” he explains.

Low economic growth and low wages growth are also a concern for the bank, as is the strengthening Australian dollar.

“The Reserve Bank would be happier if the dollar was down at 70 cents to one US dollar, but it’s sitting at around 80 cents, mainly because of weakness in the greenback,” Eslake explains.

Chance of a cut?

Although a rate hike seems unlikely, it’s worth exploring the potential for a rate cut. However, Eslake says this is also unlikely.

“Particularly now Philip Lowe is RBA governor, the bank is more worried about rising property markets, high levels of household debt and the risks to financial stability if rates were to go any lower,” he says.

Eslake explains Phil Lowe spent time working for the Bank for International Settlements in Basel, Switzerland, which warned of the risks associated with the build-up in debt before the financial crisis of 2007/2008.

“He’s very focused on this. He doesn’t see much point in cutting rates further if the only result is to encourage households to take on more debt and push up the price of housing even further. The last five years tells him that’s all cutting rates has done,” he adds.

As a result, the RBA would prefer not to cut rates again, even though the economy isn’t where the board would like it to be. As a result, the outlook for the official cash rate is no change for the best part of another year.

 

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