The Reserve Bank has cut the cash rate by 25 basis points to a record low of 1.25%; marking the first move in the official interest rate since August 2016, when the RBA dropped the cash rate from 1.75% to 1.5%.
The RBA’s statement contained a number of key changes from previous months. The RBA stated that the "decision to lower the cash rate will help make further inroads into the spare capacity in the economy. It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target”.
The RBA rarely cuts the cash rate once, so Tuesday’s 25 basis point cut is likely to be followed by a second cut, most likely at the August meeting.
Due to lower funding costs, and to protect their public image after a torrid year, banks will likely pass on most, if not all, of Tuesday’s interest rate cut. If banks do pass on the full cut, a typical borrower with a $400,000, 25-year home loan will see their mortgage repayments fall by about $55 a month.
The RBA has been reluctant to cut interest rates due to a fear of re-stoking the housing market, concerns about high household debtelevating financial risks, and because the cash rate is getting close to zero, where it is difficult for the rate to be lowered any further.
The RBA’s concerns about financial stability risks meant the central bank has delayed cutting rates despite underlying inflation remaining below 2 per cent since 2015 (the RBA targets an inflation rate of 2-3 per cent) and unemployment and underemployment remaining higher than desirable. But successful interventions by the banking regulator to improve lending practices and a cooling housing market has given the RBA greater scope to cut interest rates without risking financial stability.
Lower interest rates should boost inflation and reduce unemployment. The unemployment rate is currently 5.1 per cent (according to the ABS trend measure), but the RBA now thinks an unemployment rate of 4.5 per cent should be the target (see graph).
The RBA stated that the decision to cut rates was “to support employment growth and provide greater confidence that inflation will be consistent with the medium-term target”.