Why the Reserve Bank kept interest rates on hold

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Borrowers hoping for cheaper monthly repayments will have to wait after the Reserve Bank defied expectations and left interest rates on hold.

After 32 months at a record-low 1.5 per cent, markets were poised for a rate cut to 1.25 after low inflation data and poor wage growth – but the fabled cut failed to materialise at Tuesday’s RBA board meeting.

A table showing Australia's historic cash rate since 1990.A table showing the Reserve Bank of Australia’s cash rate since 1990.

In his statement following the announcement, RBA governor Philip Lowe cited the “significant increase” in employment, an expected 2.75 per cent growth in Australia’s economy in 2019 and 2020, and “some pick up in wages growth” as factors supporting the bank’s decision.

At odds with expectations

Markets were split before Tuesday’s meeting on whether rates would stay or go down, while ANZ and AMP had predicted a cut was probable.

Part of the RBA’s purpose in setting the monthly cash rate is to keep inflation within a targeted band, currently set at 2 to 3 per cent.

By cutting rates, lenders can theoretically lower the burden of repayment costs for their customers, and the money those borrowers save can then flow back into the economy, boost spending and boost inflation into that target band.

In a research note released before the Tuesday announcement, ANZ chief economist Richard Yetsenga noted that inflation has not managed to climb above 2 per cent since 2015 “and the most recent data suggests it has declined since late 2017”.

The most recent consumer price index (CPI) data showed inflation stalled in the first quarter of the year, below an already anaemic 0.2 per cent prediction of quarterly growth.

With that in mind, Mr Yetsenga said, cutting rates would have made sense.

The employment factor

While inflation has consistently fallen below target over the past three years, the Commonwealth Bank noted that employment data plays a vital role in cash rate decisions.

“The RBA has always been careful to tie the direction of interest rates to the unemployment rate as well,” the bank’s Global Markets Research arm said in a note to subscribers.

“Along with low inflation, the RBA wants to see how the labour market evolves. Today’s post-meeting statement was no exception.”

The current unemployment rate isn’t low enough to push inflation inside the RBA’s target band, but it is moving in that direction, Commonwealth Bank said.

“[Yesterday’s] no-change decision should be benchmarked against that backdrop,” Commonwealth Bank said.

April’s labour force data will be published by the ABS on May 16.

‘Swift response’ to weakness

Commonwealth Bank cautioned that weakness in the first-quarter CPI data has increased the stakes for the RBA and potentially reduced the threshold that ABS unemployment data would need to reach for it to cut rates.

“Previously, we thought it would take an unemployment rate of 5.25 per cent or higher to trigger a cut. Now any perceived deviation from the RBA’s projections [of 4.75 per cent in 2021] could be met with a swift response,” the bank said.

Callam Pickering, economist with jobs site Indeed, took a similar position.

“That [the RBA] wants to see ‘further improvement’ in the labour market to meet their inflation objectives is an acknowledgement that a 5 per cent unemployment rate is no longer good enough,” he said.

Mr Pickering said the RBA will likely cut rates twice in the remainder of 2019 – once in each of the next two quarters – but that the exact timing of those cuts will depend on the unemployment rate.

“A softish labour market result in May could very well lead to a cut next month [June]. A stronger-than-expected result might delay cuts a little longer,” he said.

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