Reserve Bank interest rate cut a clear sign Australia’s economy is in trouble

The historic cutting of the official interest rate to 1.25% is a clear sign that the Australian economy is in trouble and needs a helping hand.

Why else would Reserve Bank of Australia (RBA) Governor Dr Philip Lowe not only decisively cut to 1.25% but make it clear in both the RBA announcement and then later at an RBA dinner that there will be more cuts to come if unemployment doesn’t start to fall.

He is acting because growth in the economy has slowed sharply, consumer spending is weak and unemployment is showing signs that it is rising.

Sure, Dr Lowe stressed that he was confident that “the economic outlook remains reasonable, with the main downside risk being the international trade disputes’’ but he also stressed that the Australian economy had spare capacity which was likely to be around for some time.

It is this “spare capacity’’ that the RBA is taking a swing at, both to get inflation a bit higher through wage rises and prices and to get more people in work.

Aussies working hard for peanuts

According to Dr Lowe Australians have turned out to be much harder workers than anyone expected – even when wage growth remains stubbornly low.

“The labour market is turning out to be more flexible than we had earlier expected,’’ said Dr Lowe.

“The recent evidence is that when jobs are there, more people join the labour force and other Australians stay in work longer.

“Reflecting this, the participation rate is currently at a record high, despite demographic shifts that we anticipated would reduce participation.

“It is also the case that people are prepared to work extra hours when there is strong demand for their labour.’’

What Dr Lowe is saying here is that even with unemployment around the 5% mark, there is still plenty of unused capacity in the form of people who would like to work harder and longer and those on the sidelines who would like to get a job.

This is the reason the RBA cut the official interest rate to a new historic low and also forecast the possibility of more cuts this year: in Dr Lowe’s own words “it is not unreasonable to expect a lower cash rate.’’

That decision has not yet been made but his speech last night is the strongest signal yet that Dr Lowe is determined to keep cutting if the employment numbers don’t improve.

US Fed also inclined to cut

He is not alone in that judgement with even the US Federal Reserve Chairman Jerome Powell signalling that he is also looking to cut rates if required in the midst of the US trade war with China.

That announcement sent US stocks flying upwards, adding more than 400 points to the Dow Jones index as traders were overjoyed that lower rates would act as a cushion should the trade war intensify and damage US growth.

Those rises are likely to be reflected in the Australian market today, although anyone who is not buckled in for a choppy and volatile ride on the share market hasn’t been paying attention.

Banks still don’t get it

The most interesting reaction to Australia’s official interest rate cut came from our big four banks, which together showed that they really have a way to go to understand the full ramifications of the Hayne Royal Commission which exposed their bad behaviour.

While the banks can charge what they want for home loans and let the new customers decide who they will shop with for the best rate, the really big game here is the enormous stock of “sticky” existing mortgages that the banks take notice of.

It is expensive and difficult to leave an existing home loan and get a new one, which is why the big banks are always tardy and parsimonious when cutting rates for existing loans.

Cutting rates across this whole spectrum of loans is what the RBA is trying to achieve by cutting official rates – to get some more disposable income in the hands of everyday Australians to keep retail spending and investment rolling along.

Rate cuts not passed on entirely

Two of the banks – Commonwealth and NAB – cut their home loan rates by the full 0.25% across their full mortgage book.

Westpac and ANZ tried to be a bit tricky and failed dismally.

ANZ was the cheekiest, rushing in its pared down 0.18% cut and pretending they had the lowest rate on the market by comparing that rate with the other banks existing, pre-cut rates.

That fooled absolutely nobody and instead made ANZ look mean and tricky – in other words, very pre-Hayne.

Westpac pulled a similar trick, dragging out a super-low five-year fixed rate of just 3.49% for first-home buyers but then only cut rates on its massive back book of variable mortgages by 0.2%.

Again, very misleading and it will have fooled absolutely nobody, particularly those grumpy customers forced to pay higher mortgage rates than they should be.

One thing that you can be sure of is that anybody walking into any of the big banks today to open a term deposit will really find out how low interest rates can go!

However, with more interest rate cuts on the way, even those low deposit rates on offer might look good in the future.

What this episode has shown is that with more official rate cuts potentially on the way this year, the big banks will need to get their act together and potentially even take a hit to their profits to deliver the sort of stimulus hit the RBA intends for the Australian economy.