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RBA may cut but don't expect a miracle

AAP logoAAP 28/07/2016 Garry Shilson-Josling,
The RBA could cut the cash rate again next week, the second part of a two-step move begun in May, but the economy's response is likely to be disappointing. © AAP The RBA could cut the cash rate again next week, the second part of a two-step move begun in May, but the economy's response is likely to be disappointing.

The futures market tells us there's a three-in-five chance the Reserve Bank will shave another sliver off the cash rate next Tuesday after its board gets together for a cup of tea and a chat.

But it's not clear just what that will achieve.

A common theme among economists is that a cut to 1.5 per cent would be the second instalment of a two-part adjustment that began in May when the benchmark rate was trimmed to 1.75 per cent, from its previous all-time low of 2.0 per cent.

The catalyst for the May cut was a dramatic - as such things go - downward shift in the RBA's outlook for inflation over the coming couple of years.

Inflation had been expected to stay inside the two to three per cent target range over 2016 and 2017, but that was before a surprisingly weak set of inflation figures for the March quarter.

It's now seen to be below the band in 2016 with only a 50-50 chance it would be back in it by the end of 2017.

A common theme among economists is that a single quarter-point cut will not be enough to get inflation back on track.

The June quarter consumer price index on Wednesday did nothing to alter the perception that inflation will stay uncomfortably low without some form of economic stimulus.

That's a big part of the reason why another cut is expected on Tuesday.

But why lowering the cash rate to 1.5 per cent would make a difference, when taking it to 1.75 per cent was not, is a hard question to answer.

A rate cut is supposed to work in two ways.

One is to lower the exchange rate, by reducing foreign demand for Australian dollars as money managers deposit their cash somewhere else.

But even at 1.5 per cent, the Australian cash rate would still be well above the corresponding rates in the US, the UK, Japan, Switzerland, Canada and the euro area.

The Aussie dollar's appeal to the hot-money crowd will remain strong, so a boost to the economy from a significantly weaker exchange rate is a forlorn hope.

Another way lower rates are supposed to work is to encourage business investment, housing construction and consumer spending.

But even aside from the slump in mining investment, business investment is in the doldrums.

And a nasty combination of weak employment growth and slowing wages growth is restraining the consumer spending needed to get businesses investing again.

More rate cuts seem likely to have no more effect than "pushing on a string".

That's how economists describe efforts to encourage investment when the real problem is not the cost of funding it, but a lack of confidence that customers will spend enough to justify it.

Historically low interest rates have been unable to prevent a downward trend in lending for housing that's been going on for nearly a year.

Weak income growth, slow growth in rents received by investors, and prohibitively high prices are winning the battle.

The RBA may cut next week - a lower cash rate is its only weapon - but don't expect a miracle.

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