The Reserve Bank is poised to cut interest rates on Tuesday in order to counter what it regards as a deteriorating economy.
The bank's first board meeting for the year will be told that economic growth has slipped from an annualised pace of 3.6 per cent to 1.6 per cent.
It will also be told that the bank's preferred measure of unemployment is climbing at the rate of 0.1 percentage points every three months. A year ago the average quarterly unemployment rate was 5.8 per cent, but hit 6.2 per cent in the December quarter, the highest in 12 years.
The board will hear that neither consumer nor business confidence has improved in the way that would be needed to lift economic growth. And it will be told that although a cut runs the risk of re-igniting a boom in investor housing, the risk is worth taking.
Financial markets have priced in a 67 per cent certainty of a rates cut on Tuesday. They have bid down the rate on the 10-year bond market to below the present Reserve Bank cash rate of 2.5 per cent, meaning they are taking a punt on it staying below 2.5 per cent for years into the future.
A cut to 2.25 per cent would bring the typical discounted home loan rate below 5 per cent for the first time since the early 1970s. It would knock $53 per month off the cost of servicing a $350,000 loan.
If the Reserve Bank follows the first cut with a second and banks pass it on, it will have sliced more than $100 off the monthly cost of servicing a $350,000 loan loan.
The bank is fully aware that the housing market doesn't need such a boost, but it sees lower interest rates as the only tool it has to boost the economy consistent with the provisions of its Act...
Australia's latest very low inflation rate gives it room to cut, as does its preferred measure of domestically sourced inflation, which shows low wage growth and steadily climbing unemployment dampening price rises.
Up for debate at the meeting will be whether to cut on Tuesday or delay for a month in order to better prepare the market. At the conclusion of its most recent board meeting in December it said the most prudent course was likely to be a "period of stability in interest rates".
It believes that acting now gives it its best chance of keeping the Australian dollar near its present long-term low of 77.66 US cents. In January the dollar slipped below 80 US cents for the first time since 2009.In The Age and Sydney Morning Herald
Concern about deteriorating economic growth lies behind the Reserve Bank's determination to cut interest rates, most likely at its first board meeting for the year on Tuesday.
A cut in the bank's cash rate from 2.5 per cent to 2 per cent would bring the standard discounted home loan rate below 5 per cent, knocking $53 off the cost of servicing a $350,000 loan.
Although the latest official figures show Australia's unemployment rate falling, the Reserve Bank's preferred measure shows it continuing to climb.
The bank averages the unemployment rate for each quarter and compares it with the average for the previous quarter.
Board members will be told on Tuesday that over the past year the average unemployment rate has climbed from 5.9 per cent to 6 per cent to 6.1 per cent to 6.2 per cent. The averages mean that abstracted from monthly "noise" there has been no let up in the pace at which unemployment is climbing.
The board will be told economic growth figures released since it last met show the annualised pace of growth slipping from 3.6 per cent to 1.6 per cent in the space of six months.
The bank's previous forecast of rising economic growth published in November is now regarded as out of date and will be revised when new forecasts are issued on Friday.
Board members will be told that neither consumer nor business confidence has lifted since the budget, as would be needed for economic growth to climb back to its long-term trend.
Retail sales are solid but not spectacular, maintained by discounting and weighed down by low wage growth and rising unemployment.
Inflation provides no impediment to cutting rates. The headline rate is now just 1.7 per cent after the collapse in oil prices. Importantly, the bank expects lower oil prices to continue to weigh down on inflation as they feed through into a myriad other prices, something it did not expect late last year when it looked as if the collapse in the oil price would be less severe.
Rather than focusing on the unexpectedly high rate of so-called underlying inflation in the December quarter, the bank is paying special attention to the rate of inflation on so called "non-tradables" - products that are not internationally traded, which is well down on where it was a year ago, reflecting low wage growth and weak consumer demand.
"Tradables" inflation, the rate on products that are internationally traded, is now negative despite the lower dollar.
The bank is minded to cut its cash rate despite doubts about its effectiveness in boosting the economy. It is concerned that another cut may simply reignite the investor housing market and it fears it could fail in its objective of encouraging businesses and consumers to borrow and spend more. While a boost to the economy from the budget would be preferable, it isn't likely.
Another impediment is the statement the bank released after its December board meeting, saying "the most prudent course is likely to be a period of stability in interest rates".
The bank believes that enough has changed since December to release it from the commitment. The oil price has collapsed, economic growth has weakened, and the steam has gone out of inflation.
It believes that if it is clear it has to cut rates, there is little point in waiting. And it is also concerned that if it doesn't cut when it is clear it should, the Australian dollar will head back up after dropping.
Canada has just cut its cash rate to 0.75 per cent. Denmark has just cut its rate to minus 0.5 per cent. The United States is keeping its rate at 0.25 per cent. An Australian cash rate maintained at 2.5 per cent in the face of these moves would give the dollar support the bank would prefer it not to have.
The final decision will up be made by the nine members of the board, including the newly appointed treasury secretary John Fraser, who will meet in Sydney on Tuesday.
If they decide to keep the cash rate at 2.5 per cent in the face of recent developments, they are likely to indicate they intend to cut it soon, in March. But it is more likely that they will cut on Tuesday.In BusinessDay
. December 2014: After a year of finely judged inactivity, the Reserve Bank is stirring
. July 2014: RBA, Dollar overvalued, “and not by just a few cents”
. October 2013: It's over. Why there won't be any more rate cuts this year