Analysis: One Reason Why the RBA will Cut Cash Rate Tuesday
- Published on
- 30 Sep 2019, 11:25 AM
By Sophia Rodrigues
Ahead of the Reserve Bank of Australia’s cash rate decision on Tuesday, market is pricing around 77% chance of a 25 basis points cut and majority of economists are also expecting a cut.
The key question is whether the RBA will cut on Tuesday, or wait another month to get consumer price index data and updated forecasts on the economy and cut in November.
There is one strong reason why the RBA will lower the cash rate to 0.75% on Tuesday.
A lower cash rate would have a positive impact on household cashflow, and the RBA believes this channel of monetary policy is still very effective in Australia.
If the RBA indeed believes in its effectiveness then it would use monetary policy sooner rather than later, when the biggest domestic uncertainty it is facing is the strength of household spending.
At a speech in Armidale last week, Governor Philip Lowe pointed to a very interesting fact. He said there has been no growth at all in household consumption per person over the past year.
It is the first time I have seen a reference to consumption per person.
In the year to June, according to national accounts data published by the Australian Bureau of Statistics, household consumption rose 1.4% y/y, the slowest pace of growth in six years.
This means that with population expected to have grown around 1.6% during this time, the per capita household consumption fell for the first time since June 2013.
In such a scenario, the RBA’s aim would be to use monetary policy to provide a boost to household’s cashflow so they are encouraged to spend.
Governor Lowe reiterated as recently as last week that the cashflow channel of monetary policy still works.
According to Lowe, this and the exchange rate channel work as effectively as the past but some other transmission mechanisms are less effective.
Lowe gave an elaborate answer on the effectiveness of monetary policy at the Parliamentary testimony in August when he said monetary policy is less effective in some aspects, but as effective as before for cashflow and exchange rate.
“Once upon a time, when we lowered interest rates people were very quick to run off to the bank to borrow more to spend..In today's environment people don't run off to the bank to borrow more when interest rates fall; they are more likely to pay back their mortgage more quickly. So that dynamic is different.”
“The other dynamic that is different is that, as interest rates get lower and lower, it is harder for the banks to pass it through fully to the mortgage rates because their deposit rates start to bunch up around zero, and they can't reduce those anymore.”
“So there are those two aspects where it is not as effective as it previously was, but the exchange rate channel and the cashflow channel, which are two incredibly important channels, are as effective,” he said.
Last week in response to a question at Armidale Lowe said, “For every dollar of interest income received by the household sector, households pay more than two dollars of interest to the bank. So when interest rates come down, there’s a net cashflow addition to the household sector. It’s uneven, but there’s a net addition, so that still works.”
--Email: sophia@centralbankintel.com