How Low Can We Go?

Cash Rate Cut to Record Low

After 18 months of keeping rates on hold, the Reserve Bank of Australia (RBA) lowered the cash rate by 25 basis points to 2.25% at its February RBA board meeting.

The move to the lowest rate since the RBA commenced setting a cash rate target in 1990 is designed to stimulate business activity and household spending in the face of weak growth, falling commodity prices and sluggish investment.

Growth is below-trend

The RBA’s governor, Glen Stevens, stated that growth in the global economy continued at a moderate pace in 2014. However, in Australia, the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak.

“As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth.”

Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.

Low Consumer Price Index

Stevens explained that Australia’s consumer price index (CPI) recorded the lowest increase for several years in 2014.

“This was affected by the sharp decline in oil prices at the end of the year and the removal of the price on carbon. Measures of underlying inflation also declined a little, to around 2.25% over the year,” he said.

With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate.

Stevens added that while the cash rate has been stable for the past year and a half, the RBA Board has taken time to assess the effects of the substantial easing in policy that had already been put in place, and monitored developments in Australia and abroad.

“Taking into account the flow of recent information and updated forecasts, the Board judged that, on balance, a further reduction in the cash rate was appropriate,” he said.

This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target.
In reaction to the cut in the cash rate, the value of the Australian dollar immediately fell sharply to 76.35 US cents.