Mortgage holders across Australia breathed a collective sigh of relief this afternoon as the Reserve Bank of Australia finally announced a long-awaited interest rate cut, taking the official cash rate from 4.35% to 4.1%. According to the treasurer, Jim Chalmers, the four major banks have been quick to confirm that they will pass on the “full benefits” of the decision.
Such a tiny cut might not feel like much to those saddled with large debt. Remember, the cash rate rose from just 0.1% in April 2022, adding thousands of dollars a month to mortgage repayments. But it’s important to remember that, only in November, the RBA was still “not ruling anything in or out”. In other words, a rate rise was still being debated. This phrase was finally removed at the December meeting, giving confidence that a rate rise was finally off the table, but certainly not guaranteeing a rate cut any time soon.
Indeed, the RBA has been very cautious – some might say overly so – in its assessment of the different risks facing the economy in 2024. They were supported in this view by some economists, albeit a minority, as recently as last month. Again, in November last year, the RBA said it did “not see inflation returning sustainably to the midpoint of the [inflation] target until 2026.”
Today, they tell us “inflation is expected to return to the 2–3% range a little sooner than we thought.” In fact, underlying inflation is now expected to be in the target zone by June this year, a full year ahead of the forecasts published in the November Statement on Monetary Policy
While mortgage holders, renters, and the federal government will be embracing today’s news, there remains the question: what next? Those expecting rates to head south towards levels seen during the depths of the pandemic will be deeply disappointed. The RBA itself today said it “remains cautious on prospects for further policy easing,” so how might we interpret that?
The path of rates in the year ahead will depend on a couple of things. Firstly, and obviously, the path of the economy and inflation in the year ahead will dictate the timing of any future rate cuts.
But, just as importantly is where the RBA sees what’s known as the “neutral cash rate”. That is, the rate at which monetary policy is neither too tight nor too stimulatory. A Goldilocks rate, if you like. Unfortunately, this neutral rate is not fixed and possibly not even precisely knowable. This means a little guess work is involved: if the RBA cut too far too fast, they risk losing the very hard-won gains of 2024 and letting the inflation genie escape once again. Go too slowly, and an already weak economy risks stagnation and a significantly weaker labour market than we’ve seen so far.
The bank has been at pains to point out that there remains a great deal of economic uncertainty in the year ahead. One could argue that this is always the case, but it’s certainly fair to say that the US election and growing trade tensions over US president Donald Trump’s tariff policies are casting a very long shadow over growth and inflation prospects both in Australia and around the world. Australia is doubly vulnerable, both through tariffs imposed on us directly, and those imposed on China which will likely reduce demand from Australia for those imported goods.
On the other side of the equation, the labour market has been remarkably resilient, with unemployment still at just 4%, chiefly due to government spending offsetting a weak private sector. Today, the RBA has reduced its expectations for peak unemployment to just 4.2%, down from 4.5%. This is an incredible achievement when we consider what has happened in previous periods of rate rises.
Weighing up the risks for the year ahead, it feels as if the RBA is now conceding that the balance may have been tipped towards the downside. With monetary policy described in today’s release as still restrictive (that is, above the neutral rate), it’s reasonable to expect further rate cuts will be discussed at each meeting this year.
Financial markets expect rates to head slowly towards 3.5% by the end of this year. That is, another three cuts of 0.25 percentage points. Mortgage holders will be desperately hoping that the pundits are right.
• Nicki Hutley is an independent economist and councillor with the Climate Council
