Chief economist update: As low as Lowe will go

The RBA's growth and inflation forecasts and the Taylor Rule calls for just one more rate cut next year.

So there we have it ladies and gents, the answer to every Australian's question du jour, how low will domestic interest rates go?

I posed the same question about two weeks ago on this space and assumed that zero would be the lower bound (before QE).

In his outing at the Australian Business Economists' conference last night, RBA Governor Lowe couldn't be more explicit on how low the official cash rate could go:

"Our current thinking is that QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that," Lowe said.

"Because a cash rate of 25 basis points, the rate the Reserve Bank is paying on bank reserves is effectively zero - would be zero on those bank reserves."

Will we see the official cash rate lowered to 0.25%?

The overriding answer, of course, is it depends. It depends on how the US trade war - primarily with China - goes, the US-Australia interest rate differential (which largely determines the whether the AUD$ exchange rate appreciates or depreciates), among a myriad of other factors.

As I've ranted many, many times before, economics is not an exact science because it is dynamic and doesn't operate in a vacuum.

With the Fed on pause - and current expectations are it will remain on hold through to the end of 2020 - there is a strong likelihood that the RBA will opt for just one more rate cut (to 0.5%) if only to get the AUD$ lower to support stronger growth and higher inflation.

This is consistent with the RBA's forecasts in its November 'Statement on Monetary Policy" (SoMP) - GDP growth of 2.75% in 2020 and inflation of 1.75% (and of course, that footnote where it assumes another 25bps cut in interest rates by the middle of next year).

This is also consistent with the 'Taylor Rule'.

Financial Standard has always relied on that time tested work by John Taylor to estimate the required level of interest rates for a given state of the economy.

In the economics vernacular, this is known as the 'Taylor Rule' - a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions.

Applying the Taylor Rule formula, given the relative deviations of the RBA's forecast inflation (1.75% headline or trimmed mean - from the SoMP) from target (2.5%), GDP growth (2.75% in Q4 2020) from potential (3.0%) and the neutral cash rate (1.25%)...

...equals a nominal official cash rate of 0.525%.

But if only the RBA's forecasts come true, they could turn out worse or better than predicted.

Read more: RBATaylor RuleEconomicsQEFinancial StandardJohn TaylorMonetary PolicyReserve Bank
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