If the Reserve Bank was still retaining its narrow focus on keeping inflation between 2 and 3 per cent per annum, it would be cutting interest rates at its May meeting on Tuesday.
Futures traders and economists are almost certain it won’t, and will, instead, keep rates steady for the ninth straight month. Market economists are glad for the RBA’s ability to look beyond inflation rates when setting the interest rate – though opinions differ on what exactly it should be focusing on.
The domestic economic is growing, but still weak. And the currency is still high – factors that some say should lead the RBA to cut rates. But record-low interest rates, others argue, have added oomph to booming housing markets in Sydney and Melbourne, leading them to conclude raising interest rates would be the most effective way to address this.
“I think they should be cutting,” said Market Economics’ Stephen Koukoulas, an economic adviser to former prime minister Julia Gillard.
Housing prices, which have in Sydney doubled since 2009 and are contributing to high indebtedness of some households – a topic RBA Governor Philip Lowe is due to give a speech about on Wednesday. Photo: Bloomberg
“We had confirmation last week that underlying inflation has been stuck below the bottom of the target band for what, 18 months, and shows few signs of picking up.
“We’ve got no prospect of underlying inflation moving into the target.
“Add to that unemployment edging up, underemployment high, retail sales weak … to me those criteria would suggest that we need lower rates.”
If the RBA were solely concerned with inflation-targeting, it would be cutting to 1 per cent, said Capital Economics’ chief Australia/New Zealand economist Paul Dales. The Australian economy, he said, would benefit from a lower currency.
Australia’s central bank is one of the few in the world to explicitly target a set inflation band – between 2 and 3 per cent. In 2013, and again in 2016, this target was loosened to allow the RBA to target 2 to 3 per cent inflation on average over time, or “over the cycle”, significantly enhancing its ability to consider things like financial stability as well in setting interest rates.
That’s probably a good thing, Mr Dales said.
“One thing [RBA] governor [Philip] Lowe has communicated effectively is his growing concerns about financial stability. That’s why economists are thinking on these lines – governor Lowe himself said he’s concerned about dealing with a mess in five years’ time when the housing market pops.
“We think they can tolerate first-quarter inflation where it is. It’s low, but not extremely low.
“I think interest rates should be around where they are – and should stay there for a long time. It’s not an ideal situation … but now is not the right time to keep going [at inflation].”
Housing prices, which have in Sydney doubled since 2009 and are contributing to high indebtedness of some households, a topic Dr Lowe is due to give a speech about on Thursday.
In its annual budget monitor released on Monday, Deloitte Access Economics’ Chris Richardson said the RBA “had added extra Bundy to the punch at the party” by cutting interest rates twice in mid-2016, just as the global economy, particularly China, began to rebound.
“Affordability is through the floor because interest rates are through the floor,” the monitor states. “Each percentage point lift in interest rates from today’s lows would cut house prices by 7%. That’s more than double the impact on prices (and so on affordability) you’d get from cutting the CGT discount (which should be done) and winding back negative gearing.”
AMP chief economist Shane Oliver disagreed, saying many countries with lower interest rates than Australia hadn’t had the same housing price surge.
“If we’re the floor, they’re down in the basement somewhere,” he said. “I don’t think interest rates are the cause – it’s supply and demand.”
Raising interest rates by 1 per cent or so would certainly address housing affordability, Mr Oliver said. But it would “plunge the country into recession”. “House prices might come down, but people would worry about losing their jobs.”
Mr Koukoulas said while interest rates were “very important” to housing cycles, and were “no doubt” pushing yield-seeking investors into housing at a time when term deposits and other retail-friendly accounts offer low returns, other factors – like negative gearing concessions – were playing a large role in house prices.
“And you’ve got very low interest rates in Perth and Darwin, and prices there are falling,” he said. “Something else is happening. Interest rates are important, but they’re not the be-all of house prices.”
Most expect the RBA is more likely to cut than hike in coming months. Mr Koukoulas said coming data releases would be key.
“The next few labour force numbers have taken on unusually large importance,” He said. “If we get a ‘6’ in front of the unemployment figure – it’s 5.9 per cent now – and the next CPI figures confirm underlying inflation below 2 per cent, I think the market will be screaming for lower rates, even though not much is priced in at the moment.”