Last Tuesday, the Reserve Bank of Australia delivered its first rate cut in over four years.
For many, the tumultuous years of rate rises have felt like a cost-of-living gauntlet. Inflation has driven up the cost of household bills, groceries and housing, with families slashing their spending to make ends meet.
Despite the RBA’s independence from government, the rate cut falls under the shadow of a looming election, and both major parties are using the decision to pitch policies that ease the cost-of-living crisis.
On this podcast, host Kat Clay interviews Grattan experts Trent Wiltshire and Jessica Geraghty, on the RBA’s decision, what it means for the election, and Australia’s economic outlook.
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Transcript
Kat Clay: Last Tuesday, mortgage holders across Australia breathed a collective sigh of relief as the Reserve Bank of Australia delivered their first rate cut in over four years.
For many, the past four years have felt like a cost-of-living gauntlet. Inflation has driven up the cost of household bills, groceries and housing, with families slashing their spending in order to make ends meet. While the RBA is independent from the government, it’s no wonder that with a looming election, the decision is being used by both major parties to pitch policies that ease the cost-of-living crisis.
I’m Kat Clay, and in this podcast, I wanted to bring in two of Grattan’s economic experts, Trent Wiltshire and Jessica Geraghty, to talk about the RBA’s decision. So, we’re going to dig into what’s happened and what this means for the upcoming election, and also the economic outlook for Australia.
Jess, it seems like there’s a really palpable sense of relief across communities at the moment, even though the rate cut is relatively minor when compared to the rises that we’ve experienced.
There’s been chatter over the past year about when is the right time to cut rates, so why did the RBA decide to cut rates now?
Jessica Geraghty: So, the RBA decided to cut rates by 25 basis points or 0. 25 percent because the board has more confidence that inflation is heading back to the target range of 2-3%. So, we got the latest inflation data a few weeks ago, and that showed that underlying inflation, which is when we strip out the really big price changes that have come down to 3. 2 percent in December last year, and that was lower than the Reserve Bank had expected. There’s been a couple of other indicators as well that have suggested there’s less inflationary pressure in the economy than the bank had expected. So specifically wages growth, private spending.
But the governor made the point that it was a close call because there, because the bank looks at a lot of information and some indicators suggested that actually there was more inflationary pressure in the economy. So specifically, the labour market is still quite tight. And what that means is that unemployment is low, underemployment or people who have jobs but are looking for more hours, that’s come down as well.
Youth unemployment is really low. So, they suggest that maybe there are these inflationary pressures. But on balance, the board decided that enough progress had been made to bringing inflation down to warrant a rate cut.
Kat Clay: Yeah, thanks for explaining that, Jess. Trent, I mean, the question that many people will be asking is, we’ve had one rate cut. Will we see more rate cuts this year?
Trent Wiltshire: So based on what the RBA board said and what the governor said in her press conference after the meeting. This is probably going to be only the only cut for this cycle or maybe one more. They were really clear about not locking themselves into further cuts. So not issuing forward guidance about where rates are going to be.
But in saying that it was a strong suggestion that there won’t be many cuts if at all. So really shied away from what we’d term forward guidance. So, you know, suggesting what’s going to happen to rates. And Michelle Bullock was really making it clear that this is possibly the only one. Or maybe one more, so that compares to what the market expectations are, which is, you know, what the financial markets expect based on trading of different financial products that they were expected about three more rate cuts.
It might have come a little bit since the decision, but about three more rate cuts. So, four in total, but the RBA board doesn’t think this is going to happen. So, you have to look at the forecast to determine this. So, the forecasts were that trimmed mean inflation, or underlying inflation was going to fall to just 2.7 percent, which is a bit higher than what they used to have it at 2. 5%. So that’s based on this market interest rate projection. But the board really doesn’t think that’s going to happen, they only see, you know, maybe one more cut. Another thing of interest from the governor’s presentation was that if inflation reverses course and, you know, starts to tick up again, the RBA will have to raise rates.
So, it really, as Jess said, it was a line ball call. Possibly the only cut we’ll see, but you know, maybe one more this year. You know, when could this cut happen if it does happen? Well, looking at the, the data releases coming up. So, the next quarterly CPI is coming out on the 30th of April. So, the next board meeting after that is actually on the 19th and 20th of May.
That’s actually after the last day of the election, which is the 17th of May. So, you know, bringing the political sphere into this, it’s unlikely we’ll see, or very unlikely we’ll see, another cut before the election.
Kat Clay: And Jess, there’s a lot of uncertainty both here and abroad at the moment. How does that play into these kinds of forecasts?
Jessica Geraghty: That’s exactly right, Kat. It’s a really complex international environment at the moment and it is really difficult to incorporate that information into forecasts because there’s so much uncertainty about what will happen. You know, obviously there’s a lot of trade tensions at the moment.
If we do see tariffs, that can, increase inflation overseas, which then does come back to Australia. But at the same time, we might also see lower economic activity around the world, lower demand for our exports. And so, the international environment at the moment, it might have conflicting impacts on our economy and on inflation in Australia.
And there’s just too much uncertainty to properly incorporate that into forecasts. So, it’s something that the Reserve Bank will be paying close attention to. But we’re not sure exactly how that will affect the economy.
Trent Wiltshire: That’s right. So, the Reserve Bank, when it does its forecast, thinks about the most likely outcome, but does note these sorts of what we call tail risks that may influence things, but, you know, you wouldn’t say is the most likely outcome.
Kat Clay: Trent, one thing that does come up as well when we’re having these kinds of discussions, what does it mean for the housing market? I mean, we’ve got a rental crisis, we’ve got mortgage owners who have been struggling with the high interest rates. Will this affect the cost of housing?
Trent Wiltshire: So, yeah, certainly the case that Reserve Bank decisions are often seen through the lens of what does it mean for the housing market and what does it mean for mortgage holders? And that’s to be expected, given the amount of debt that many people hold. Looking at the research in this, it is the case that lower rates do tend to result in rising prices.
In this case, as we just spoke about, we’re probably going to see this cut and maybe one more. So, I don’t think these rate cutting cycle will lead to a boom in prices. Some RBA research found that a percentage point cut interest rates that’s expected to be sustained can lead to prices rising by about 8%. A 0. 25 percent cut means a, you know, it’s a 2 percent increase. CoreLogic ran something similar, and they found that a percentage point cut leads to about a 6 percent rise in prices. So, no. Modest. But not insignificant.
It should be noted that, you know, at the moment prices are actually falling in Melbourne and Sydney. So, this just might see prices start to bottom out. On the other side. You know what’s holding back prices rising any further? Well, obviously prices are very high at the moment already. Like unaffordability is a really major issue. Rates are still very high and that have come down a touch. Population growth’s strong.
But it’s slowing. So, you know, this rate cutting cycle probably won’t mean too much for the housing market, although we do know there is sort of a tendency for the market to have sort of momentum, confident swing. So, this may swing it a little bit.
What lower rates won’t do is directly lower rents. So actually, the RBA put out some research last year that found that landlords don’t tend to pass on higher rates through to higher rents. So, the reverse is also true. So, what matters for rents? We know renters have really been struggling recently with rents rising rapidly over the last few years.
What really matters for them is the imbalance of demand and supply in the market. So, the number of houses being built are available and the number of people here. So, we know there’s been strong population growth, and we haven’t been building enough houses recently. So that’s why we’re seeing rents rising.
Kat Clay: The good thing is that lower interest rates might help boost housing construction. Is that right?
Trent Wiltshire: That’s right. So that is another channel how interest rates work. So, one of those is through how it affects construction activities. Lower interest rates do tend to boost housing construction.
That’s because when rates fall, it becomes easier for property developers to borrow. Buyers can borrow more. So, they’re more likely to, you know, go and buy an off the plan apartment. So, and that sort of stimulates construction as well, and also the mechanism of lower rates leading to prices starting to rise. When prices rise, that also encourages developers to build.
So that’s probably one important thing we might see from, this rate cutting cycle, if it’s a, if it’s a cycle is we might see housing construction start to pick up, which is, you know, a really welcome development.
Kat Clay: Jess, we talked about in the introduction that we haven’t necessarily seen the unemployment rate fall. But what do you think is going to happen with jobs here? Do you think we will see the unemployment rate fall?
Jessica Geraghty: Yeah, so what we usually see when interest rates are cut is that unemployment does fall. And that’s because lower interest rate means it increases consumption and spending. So, I’m paying less on my mortgage. I have more money to spend going to the movies or buying a new car. And so, we see this increase in consumption and economic activity and firms need to bring on more workers to meet that demand.
But as you pointed out, the labour market is still quite tight and unemployment and other indicators are still really low.
So, the governor pointed out that it is unique to be in a situation where inflation is coming down while unemployment is still quite low. And as an aside, this is a really good thing. You know, we know that unemployment is really harmful for people in the short term, but it also has long-term impacts on their income, their employment prospects, and their wellbeing.
So having low unemployment, this outcome is a great result. It’s unique amongst our peers. So, our other peer economies like New Zealand and Canada, they’ve had much bigger increases in unemployment as they’ve brought inflation back down, and this was a deliberate strategy of the reserve bank.
They were willing to accept inflation staying a bit higher for longer, bringing it down more gradually so as not to spike unemployment. But if we look at the at the at the labour market, low unemployment and strong growth in jobs has really been in the public sector. So, jobs particularly in health, aged care, disability care, while the private sector employment growth has been much weaker.
Now, we know that those are the jobs that are most sensitive to interest rates. And so, we should expect to see a pickup in jobs there, but it remains to be seen how we’ll actually meet that labour demand. So, one way is to bring more people into the workforce, more people into jobs, but as we’ve discussed, unemployment is already really low.
The participation rate is at record highs, and so it’s not clear that there’s a lot of extra people that we can bring into, into work. Another option is that firms might increase their investment in productivity enhancing technologies to allow them to meet extra demand without having to bring on a lot more workers.
But a real risk is that firms increasingly start competing with each other, and with the government as well, for the existing pool of workers. And the issue there is that as they increase competition, wages go up and that leads to inflation picking back up again. Putting aside the question of how we actually meet the labour demand, we usually say that a rate cut is good news for, for jobs and for unemployment.
Trent Wiltshire: You say, Jess, it does go to the risk, the riskiness of the RBA strategy though, to, to start cutting rates when the unemployment rate is so low, it’s actually come down a little bit from where the RBA had expected as well. So, the risk is that they’ll start cutting rates. We do see a bit of a, you know, pick up in the labour market.
The unemployment rate falls a little bit more, way to start to grow a little bit faster again. We know productivity growth is weak. That’s a recipe for higher inflation. So that might mean the inflation rate doesn’t continue to fall, and the RBA is forced to actually raise rates again.
I think that’s the big risk. I guess that’s the criticism of the RBA decision we’ve seen in the last couple of days.
Jessica Geraghty: Yeah, that’s exactly right, Trent, and unemployment is sitting below that, the level that the bank thinks is the sustainable, or the rate of unemployment that’s consistent with steady inflation. It’s really hard to actually identify that number. It is a judgment call, but it is definitely a risk.
And we’ve certainly seen the case overseas that once inflation starts coming down, there’s no golden rule that says it has to keep coming down. You know, it’s quite possible that inflation can pick back up again.
Trent Wiltshire: Or even if it just remains flat, so we know inflation is at 3. 2 percent now, it’s still a fair way away from the 2. 5 percent which the RBA is aiming for, so if it gets stuck in the low threes, which means rates will have to rise again.
Kat Clay: Trent, I mean a question for you. Do you think this rate cut means the economy is going to rebound?
Trent Wiltshire: So, I don’t think so. For the first reason that we’ve just spoken a little bit about, that, you know, this is probably going to be only one or maybe two cuts, so it’s not the start of a huge rate cutting cycle that really will, you know, kickstart the economy or see it boom. So, the RBA noted even with the right cut monetary policy settings are still restrictive, still above what they think is sort of the neutral rate where the economy’s, you know, it’s sort of trend growth rate, which that’s at about 3. 5 percent with the cash rates now at 4. 1%. So, it’s still a little bit restrictive.
So, it’s, it does go to an important point. The RBA’s job when it’s moving interest rates is to try and stabilize the economy. So, it sets rates so that demand in the economy equals the supply or how much we can produce. Importantly, the RBA doesn’t directly influence how productive we are or how fast our economy grows in the long run. The RBA’s really job is to think about that short run management of the economy to try and, you know, get that sweet spot of low unemployment and low inflation. But it doesn’t actually try and think about how to generate long term economic growth. So, to get our economy booming and incomes rising, we need to get productivity growth up. And that really boosts potential. That’s the way we get, wealthier in the long run.
So that begs the question, what can the government do to actually boost the economy? So, we’re in this you know, unique situation where the RBA is cutting rates, even with the economy running quite hot. So, if the government, you know, tried to spend money to boost the economy in the short run, well, that actually won’t really lead to more growth.
What more government spending will do is actually, you know, it’ll create jobs in one sector, but that’ll actually just draw jobs away from a different sector. So that’s what, when economists talk about crowding out, this is the exact situation. The economy’s out or beyond full employment, further stimulus yes, might create jobs in some sectors, but it’ll just mean other areas you know, have a lack of workers. We’ve seen a bit of that happening actually over the past few years. Government spent a lot on things like healthcare, disability care, age care, you know, really important things for our society. But just where we are as an economy, it means that’s, these workers have been pulled away from private sector jobs.
You know, if you look at the stats, government spending as a share of the economy is at 29%. So outside of COVID, that’s the highest point in at least 60 years. So, it just goes back to the point that, you know, are we going to see a boomy economy? Not really, because the economy is actually already running quite hot.
It doesn’t feel like it, but it is. So, we really need to focus on that supply side to get our economy more productive so we can our incomes in the long run.
Jessica Geraghty: Yeah, Trent. And when you say that the economy is booming, but it doesn’t feel like that is because we do have low growth, but we are at capacity. And it’s just that our capacity is not increasing because productivity is so low at the moment.
Kat Clay: That’s good segue for us, Jess, to talk about productivity. I mean, our friends at the Productivity Commission have been you know, even opening up their website to suggestions from the public for ways to increase productivity in Australia. I think my favourite has been Japanese style toilets throughout the country to increase productivity.
But I want to hear from you guys. I mean, what are we recommending the government, whoever it is, you know, either side of politics do to make Australia more prosperous in the future?
Jessica Geraghty: Yeah, as you said, Kat. Productivity is a really important question. Productivity matters because it’s what fuels our real income growth over time. It’s what allows our economy to expand. And, you know, indeed, over the last few years, we’ve seen our real incomes go backwards. So, it’s really important that governments are thinking about productivity, whoever’s in power, I guess another long-term challenge is around the budget. you know, if we strip away all the short-term factors, we have this, you know, a deficit, like a structural deficit, and that means it’s going to be harder for us in the future to meet the demands that come with. an aging population, climate change, those kinds of challenges. we really need the government and our policy makers to be thinking about how we can expand the capacity or the potential of our economy.
And thinking about productivity, I mean, productivity is not something that you can just fix with a single policy or a single tool. It’s the outcome of policies across a whole range of areas like health, education, and there’s also a lot of productivity growth that’s out of the hands of governments. You know, it’s a function of business decisions, technological developments like AI And so when we think about what governments can do, if we’re looking in the macroeconomic space, what governments can do is try and create the conditions that allow better productivity growth. You know, we think about things like improving, competition and more competitive economy is more productive, and things like how we can boost innovation. So, firms coming up with new ideas, but really importantly, allowing or making it easy for firms to soak up really good ideas from around the world and to, to implement them. And we can do that through policies like. tax reform, thinking about how to make our tax system more productive and more effective, but these are just a couple of examples, you know, as you said, even the Productivity Commission for this, inquiry, I think they had about 450 ideas submitted. So, there’s certainly no shortage of ideas as to how we can be more productive or what governments can do. The challenge is identifying which policies are the most Effective, which will give us the most bang for our buck and actually implementing them in a, you know, sustainable long-term way.
Trent Wiltshire: I think another one, you know, very much linked to the productivity idea is that how do we make better use of our existing talent pool of workers? So, you know, in Australia, we are highly educated workforce, but there are barriers that stop people either participate in the labour force, working as many hours as they would like, or, you know, utilizing their skills to the fullest potential.
And some of the things Grattan has talked about a lot in the past, so such as, you know, removing barriers to participation, things like improving access to childcare. There’s been some good progress there, but still, we know that access to childcare is unequal across different areas.
Some sort of boring sounding reforms, like reforming occupational licensing and skills recognition processes. So really micro kind of stuff but potentially have big economic payoffs and allow people to work across states or work in different jobs that can improve their or boost their incomes. Grattan has done a bunch of work on how we can improve the skilled migration system. Currently, we know it’s too slow, it’s too expensive and we don’t select the most skilled candidates.
So, there’s a lot of reforms there. And then we know that when migrants arrive here, often they face barriers to put their talents to use as well. So, it’s a lot of things we can do there. Jesse also mentioned tax, tax reform. So, you know, we haven’t seen major tax reform for a long time. It can be productivity enhancing if we do it well.
You can think of things like a stamp duty land tax swap. Another one that Grattan has talked a lot about, even considering raising the GST, but that comes in combination with lowering personal income tax rates. So, these big ideas, politically difficult often but big ideas that may actually boost our productivity growth, which will boost our real income.
Hopefully we see the major parties and even the smaller parties, if they potentially holding the balance of power, offer some big ideas to make Australia more prosperous country in this coming election campaign.
Kat Clay: Thank you so much, Trent and Jess. That was a fantastic explainer of the RBA’s decision and where the economy is headed and how potentially governments can make it more productive.
If you’d like to read our research on this particular topic, please do check out our website at grattan.edu.au or find us on social media at Grattan Institute. As always, please do take care and thanks so much for listening.