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The Reserve Bank of Australia (RBA) is expected to cut the benchmark cash rate by 25 basis points at its monetary policy meeting in May, with another 25 bps cut likely to follow in August, according to the latest report from ANZ Research, following the much lower-than-expected outcome for core inflation for the first quarter of this year.
An RBA easing in May will come at a time when the global economy appears to be improving somewhat and domestically the labour market appears to be in good health, with this boosting consumer sentiment to well above average levels.
Regardless, the low inflation outcome highlights that the economy needs to grow faster to generate the outcome the RBA has been tasked with achieving.
Even 50bp of easing may not be enough to eventually deliver the required boost to inflation based on recent evidence, especially when its considered that (a) it’s harder for cuts to impact lending volumes given both the tightening in lending standards, particularly the fuller assessment of a borrower’s total liabilities and the very high mortgage rate assumed in affordability calculations; (b) the AUD appears to be less responsive to interest rate differentials (see our recent report on this question); and (c) many deposit rates are already zero, the report added.
This raises some uncomfortable issues about the long-run effectiveness of inflation targeting in a very low-inflation world, an issue with which many countries are grappling.
But absent a comprehensive review of the inflation targeting framework we would expect the RBA to continue with a ‘best endeavours’ approach. This means setting overall monetary policy at a level it thinks will deliver sufficient upward momentum to core inflation to eventually reach the target band.
"Regardless, the increasing likelihood of the cash rate falling to 1 percent in the near-term means the RBA would already be considering questions about the lower bound for the cash rate and what might happen after that. We think these issues will increasingly feature in analysts’ discussions about the outlook for policy if the RBA does deliver a rate cut in May," ANZ Research further commented.
