(Bloomberg) -- How the mighty have fallen.
Australia’s record low interest-rate following Tuesday’s cut underscores the demise of its economic exceptionalism: swept up in a wave of global disinflation, policy makers had little choice but to step in line with international peers as a strengthening currency threatens to push prices lower still.
It’s a far cry from five years ago when the benchmark rate was a developed-world high 4.75 percent and the local dollar was worth more than the greenback as a mining investment bonanza went into overdrive.
Reserve Bank of Australia Governor Glenn Stevens, one policy meeting away from retirement, will leave his deputy and successor, Philip Lowe, with an inheritance that’s confounding counterparts worldwide: very low inflation and limited policy ammunition to combat it. The best result for Australia would be a depreciation in the exchange rate, but with interest rates low and even negative across the developed world, yield-hungry investors are proving tough to discourage.
“The RBA’s decision seemed to reflect a particular fear that lack of policy action would have placed further undesired upward pressure on the Australian dollar,” said David Bassanese, chief economist at BetaShares Pty. in Sydney. “The post-Brexit easing in monetary conditions -- including delayed U.S. rate hikes -- has helped force the RBA’s hand.”
Treasurer Scott Morrison, who has the means to help the central bank, isn’t about to open the government’s pocketbook. He’s working under the shadow of a potential ratings downgrade and is committed to cutting the budget deficit to avoid being cast as the man who lost Australia’s AAA rating, with all the political damage that would inflict on his economic credibility. Yet he’s aware of the central bank’s difficulties.
“It’s a low inflation world,” Morrison said after the rate cut. “It’s a world where trade growth is very, very soft, where investment growth is very, very soft. So this is the new norm.” He reiterated the government can’t afford to slip on budget repair.
Indeed, JPMorgan Chase & Co., Morgan Stanley and Macquarie Bank Ltd. anticipate Lowe will need to reduce the cash rate to 1 percent in the second quarter of next year. The RBA on Tuesday cut its benchmark rate by 25 basis points to 1.5 percent.
The central bank is trying to navigate the end of a once-in-a-century mining investment boom by relying on services like tourism and education to pick up some slack. But while Australia’s economy has grown faster than the central bank predicted, core inflation and wage growth are both at record lows, and the Aussie has rebounded about 10 percent from its mid-January trough.
“Recent data confirm that inflation remains quite low,” Stevens said Tuesday. “Given very subdued growth in labor costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.”
The one advantage for incoming Lowe will be that Australia’s booming house prices appear to be coming under control following a crackdown on lending to investors and new supply due to come on line. As a result, rate cuts probably aren’t going to reignite the property market in the way they once did.
“The board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting,” Stevens said in his statement explaining the decision.
A number of economists now expect the RBA to remain on hold for the rest of the year. More cuts might be needed if inflation remains low and the currency strengthens.
“The most effective stimulus for the domestic economy outside of fiscal policy now lies with the currency,” said James McIntyre, head of economic research at Macquarie Bank. “And if policy elsewhere poses a threat to the economy’s adjustment through a potentially higher Australian dollar, then the RBA will be drawn into defending the inflation target.”