Why did the RBA cut rates in June?
Today, the Reserve Bank of Australia (RBA) cut the official cash rate by 0.25 basis points to 1.25 per cent. Why did they do it?
MY LIVE REACTION TO THE JUNE RATE CUT
You can read the full statement, which I recommend. You can also watch my live reax (on the right).
In short, the RBA cut rates for two main reasons.
1. The RBA cut interest rates to boost employment.
The RBA reckons that Australia’s labour market is pretty soft with substantial “spare capacity”. Spare capacity refers to unused resources, labour in this case, that are sitting around and NOT contributing to the economy.
According to the RBA, unemployment has increased and overall wage growth remains low — all indicators of such spare capacity. The RBA further believes that unemployment can go lower (as Governor Philip Lowe said in his statement, “the Australian economy can sustain a lower rate of unemployment”), and the central bank hopes that the reduced cash rate can help stimulate the economy and create more jobs BY reducing the level of spare capacity.
“Today’s decision to lower the cash rate will help make further inroads into the spare capacity in the economy. It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target. ”
2. The RBA cut interest rates to boost inflation (back into the target band)
The RBA’s target band for inflation is between 2 to 3 per cent over the course of the business cycle. The central bank forecasts underlying inflation, which strips out volatile price changes, will only be 1.75 per cent in 2019, and touch the bottom end of the band at 2 per cent in 2020. By changing the cash rate, the RBA wants to move inflation back into the target band by stimulating consumption (because lower interest rates make it less attractive to save) and investment (because lower interest rates make it cheaper to borrow money and invest).
But why do we want to avoid low inflation? Isn’t high inflation a bad thing?
WHY IS LOW INFLATION BAD NEWS?
Low inflation is a problem for two reasons. One, if prices are low and expected to fall further, people will delay their consumption until prices are cheaper. But if they postpone spending, demand will fall and firms will require fewer workers and unemployment will rise and...it’s a bleak picture.
Two, low inflation relates to low wages growth. And if wages aren’t growing people aren’t spending and their living standards aren’t improving. This is not a great situation either.
The RBA has acted in June to stimulate consumption, boost employment and guide inflation back to more healthy levels. And the central bank isn’t finished yet! In a speech tonight, Governor Lowe suggested rates could go as low as 1 per cent, depending on economic conditions.