Why the RBA could hold back on future rate cuts

By Gerv Tacadena

The Reserve Bank of Australia's back-to-back rate cut was already expected by some market watchers who are predicting another round of cuts later this year

The Reserve Bank of Australia's back-to-back rate cut was already expected by some market watchers who are predicting another round of cuts later this year. However, the bank seems to have already hinted that this recent cut would be the last one for a while, an industry observer said.

A 1% cash rate could send shivers down the spine for some — if this happened years ago, it would already be considered "emergency level", UTS Business School professor Warren Hogan said in a think piece in The Australian Financial Review.

However, considering how the global markets are performing, this low level of interest rates is increasingly becoming the norm given sluggish inflation, high debt levels, and subdued economic growth rates.

"Australian interest rates, like those in most advanced economies around the world, appear to be stuck at extraordinarily low levels with little prospect of going back to what was once considered to be normal. Right now a Reserve Bank cash rate of 3% looks very high," he said.

Also read: Rate cuts likely to bring more first-home buyers to the market — REIA

Two of the main concerns the RBA considered when making its decision whether to cut or maintain the rates were inflation and the labour market. Board members observed that underlying inflation had been below the 2% to 3% target range for three years, reflecting the sluggish growth in wages.

With the rate cut now down by 50 basis points to 1%, the central bank is expecting inflation rising to 2% over the year ahead.

"The bank needs to observe the economy for a period of time to see if this is playing out. Some early signs of better conditions in the housing market were noted in yesterday's statement. Business confidence appears to have improved after the federal election while the risk of a deterioration in US-China trade talks has abated for now," Hogan said.

However, Hogan said the RBA seems to be hinting that further rate cuts, as expected by the market, are not certain and that other policies should be laid out to help stimulate the economic activity.

"The board noted that it ‘will continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy’. The 'if needed' did not appear in the last statement," Hogan said. "After a short, sharp adjustment to the stance of monetary policy, the Reserve Bank should now sit back and watch how it all plays out before considering their next move."

One of the policies that Hogan thinks would be a great start is the tax reform promised before the federal election.

"The immediate tax relief for low and middle-income earners will be an important stimulus to demand in the economy. Just as important will be legislated future tax cuts. The prospect of lower income tax rates in the future will give consumers more confidence to spend now," he said.

Hogan said many Australians are suffering from low levels of wealth, subdued income growth, and high levels of debt, which continue to grow.

In fact, mortgage debt has continued to balloon faster than the value of properties, with house prices declining for a fifth consecutive quarter in March, figures from the Australian Bureau of Statistics show. Furthermore, the housing downturn has extended the decline in household wealth per person, which decreased by $1,500 to $404,566, according to a recent Your Mortgage report.

"The prospect of a lower income tax burden in the future will help consumers get to this point of comfort with their finances and help them start spending in the period ahead," Hogan said.

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