Monetary Policy update: October 2019

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Australia’s cash rate is now 0.75 per cent. If this seems low, it’s because it absolutely is.

Think about it this way. During the worst of the Global Financial Crisis in 2008/09, the LOWEST the cash rate reached was 3 per cent. 

Is Australia in a worse position than during the GFC? I’m not sure this is correct. The global risks (the ‘downsides’ to global economic growth) don’t seem as bad as during the GFC. But there still are risks to domestic and global economic growth.

Let’s have a look at three reasons why the Reserve Bank of Australia decided to cut the cash rate to 0.75 per cent in October 2019. They’re taken from the RBA’s statement following the October decision.

Reason one: the RBA is worried about the state of the global economy

In its decision to cut the cash rate in October, RBA Governor Phillip Lowe stated that the risks to the global economy “are tilted to the downside”.

Part of the reason? The current trade war. As Dr Lowe says: “The US–China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty.”

The fear is that the global economy growth will slow and this will drag Australia’s economic growth lower. Cutting the cash rate is a move to support domestic growth in this uncertain environment.

Reason two: the Australian economy is growing slowly

Here’s Dr Lowe’s concern: “The Australian economy expanded by 1.4 per cent over the year to the June quarter [2019], which was a weaker-than-expected outcome.” Given this, the RBA believes it’s appropriate to have a more expansionary monetary policy stance to speed up the economy.

But, overall, the RBA identifies a number of elements that are positive for Australia’s economic growth. “The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets and a brighter outlook for the resources sector should all support growth,” Dr Lowe said.

So. Some positive signs, but not enough to keep interest rates on hold.

Reason three: the RBA thinks domestic unemployment is too high

The RBA is worried about rising unemployment and low wages growth. 

As Dr Lowe said: “forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate. Wages growth remains subdued and there is little upward pressure at present, with increased labour demand being met by more supply.” 

By cutting the cash rate, the RBA is hoping to stimulate aggregate demand, boost the demand for goods and services and thereby boost the demand for labour (aggregate demand).

So what happens next?

Not sure. The RBA is likely to stay on hold in November but some economists expect another rate cut before the end of the year. 

Also, what about fiscal policy? Many economists are calling for the federal government to move fiscal policy to an expansionary stance to match the RBA’s expansionary monetary policy stance.