Australia cuts key rate to record low, ending near 3-year pause

The cut is a response to weakness in Australia's economy due to falling house prices and the US-China trade war

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    The US-China trade war has hurt Australia's economy, leading the country's central bank to cut interest rates for the first time in almost three years [File: Jessica Shapiro/Getty Images]
    The US-China trade war has hurt Australia's economy, leading the country's central bank to cut interest rates for the first time in almost three years [File: Jessica Shapiro/Getty Images]

    Australia cut interest rates for the first time in almost three years to guard against a darkening global backdrop and attempt to revive a slowing economy and tepid inflation at home.

    Reserve Bank Governor Philip Lowe made his first adjustment to the cash rate since taking the helm in September 2016, cutting by a quarter-point to 1.25% Tuesday as expected by money markets and economists. They also see the central bank following up with another cut within three months.

    "Today's decision to lower the cash rate will help make further inroads into the spare capacity in the economy," Lowe said in his post-meeting statement. "It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target." The governor didn't provide any new forward guidance.

    Lowe's cut comes against the backdrop of an intensifying trade dispute between the world's economic superpowers and signs of weakness emerging in Australia's previously roaring jobs market. The country's economy slowed in recent quarters as tumbling property prices -- led by a 15% fall in Sydney -- left households feeling poorer and weighed on consumer spending.

    "The board flagged that risks have increased to the downside this month, particularly in the global economy, with the U.S. escalating its trade disputes," said Sarah Hunter, head of macroeconomics at BIS Oxford Economics in Sydney. "In contrast, their assessment of the outlook for the domestic economy is largely unchanged from last month -- households are still the weak link."

    The RBA eased as pressure mounts on the U.S. Federal Reserve to reverse some of last year's tightening to prop up inflation and counter risks from rising protectionism. St. Louis Fed chief James Bullard said Monday that "a downward policy rate adjustment may be warranted soon," marking the first time a Fed official has publicly suggested the need for a cut since the central bank held rates in January.

    The Australian dollar rose after the RBA decision, before trading little changed at 69.79 U.S. cents at 4:43 p.m. in Sydney.

    In his statement, Lowe noted some improvement in the housing market, with the rate of price declines slowing and housing credit stabilizing. An easing of lending rules last month combined with the well-flagged prospect of rate cuts may have encouraged buyers.

    Along with a boost of confidence from Prime Minister Scott Morrison's center-right government's surprise re-election last month -- on a platform of tax cuts -- the short-term prospects appear a bit brighter.

    But structural problems remain. Data out Wednesday is likely to show GDP rose an annual 1.8% in the first three months of this year, almost a percentage point below the economy's speed limit. The central bank needs growth of more than 2.75% in order to soak up spare capacity and drive down unemployment.

    "There has been little further inroads into the spare capacity in the labor market of late," Lowe said. Unemployment climbed to 5.2% in April after having held around 5% for several months before that.

    The escalating trade war further clouds the outlook: Australia is the most China-dependent economy in the developed world.

    "Downside risks stemming from the trade disputes have increased," the governor said. "Growth in international trade remains weak and the increased uncertainty is affecting investment intentions in a number of countries."

    The RBA is betting that if the jobless rate grinds lower, workers will eventually be emboldened to ask for larger pay rises and price pressures will then flow through to inflation. Price growth has largely stayed below the bottom of the central bank's target inflation range of 2-3% for the past five years.

    More worryingly, a report Monday showed an 8.4% slump in job advertisements, which suggests the RBA might need to work on reviving the labor market before it can make headway on lowering unemployment.

    "The policy guidance was dovish," said Sally Auld, a senior strategist for interest rates at JPMorgan Chase & Co. in Sydney who predicts the cash rate will fall to 0.5% by mid-2020. "It gives the RBA maximum flexibility to react to developments as they occur, whether that be a further deterioration in global data or weaker domestic labor force data."

    The RBA chief will speak in Sydney at 7:30 p.m. in an address entitled "Today's Reduction in the Cash Rate" and hold a Q&A session from 7:50 p.m.

    SOURCE: Bloomberg