Chief economist update: The path of monetary policy according to Lowe

"Toto, we're not in Kansas anymore."

The Reserve Bank of Australia's (RBA) decision to cut the official cash rate to a fresh record low of 1.25% takes the country's monetary policy into uncharted waters. More uncharted it would be if JP Morgan's prediction that rates will drop to as low as 0.5% by 2020 proves accurate.

Perhaps. Mounting expectations the US Federal Reserve would reduce borrowing costs twice by 25bps each this year, the ongoing/escalating trade war and its negative impact on already slowing global growth, and the rising likelihood of a US recession (as indicated by the inverted yield curve) make this a real possibility.

Governor Philip Lowe's statement after the conclusion of the RBA's June 4 board meeting doesn't offer much indication of the way forward.

As in the May statement, the economy is expected to grow by 2.75% this year and the next; employment growth is strong but could be better; inflation is lower than expected but "the central scenario remains for underlying inflation to be 13/4 per cent this year, 2% in 2020 and a little higher after that".

What's more revealing is Lowe's dinner speech on the same day explaining the rate cut and addressing four questions in everyone's mind.

The four questions he thought it  useful to answer are the following:

1. Why did the board act, after having held the cash rate steady for so long?

"The answer is the accumulation of evidence. As you would expect, the Board is constantly sifting through masses of data and seeking to understand what are often conflicting signals about the economy. As we have gone about this task over recent times, there has been a progressive accumulation of evidence in support of two conclusions," Lowe said.

"The first is that inflation pressures are subdued and they are likely to remain so.

"And the second and related conclusion is that there is still significant spare capacity in the Australian labour market."

2. Are there more interest rate reductions to come?

"The answer here is that the board has not yet made a decision, but it is not unreasonable to expect a lower cash rate. Our latest set of forecasts were prepared on the assumption that the cash rate would follow the path implied by market pricing, which was for the cash rate to be around 1 per cent by the end of the year," he said.

One more rate cut but ... "much will depend on how the evidence evolves, especially on the labour market".

3. Should the reduction be fully passed through to mortgage rates?

"Yes, this reduction in the cash rate should be fully passed through to variable mortgage rates," he replied.

4. What about the savers - has the board forgotten about them?

"Today's decision will reduce their income from this source and we understand why they would be disappointed with the outcome of today's meeting," he said.

"At the same time ... the board considered what was best for the overall economy. Our judgement is that lower interest rates will help the economy as a whole.

"In time, we would expect the lower exchange rate and the boost to disposable income to lead to more jobs, lower unemployment and a stronger economy. This should benefit us all, although I recognise that in the short run the effects are felt unevenly across the community."

Read more: Reserve Bank of AustraliaJP MorganPhilip Lowe
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