Westpac has today tipped the Reserve Bank of Australia (RBA) will cut rates by 25 basis points in October, before reducing rates by the same size again in February.

In its previous forecast on 24 May, Westpac’s economists had originally anticipated the next cash rate cut (besides those it correctly forecast for June and July) would come in November, but today they’ve brought forward the timing of this forecast by a month.

Westpac Chief Economist Bill Evans said that by October, the path of the unemployment rate will be “sufficiently contrary to the RBA’s plans”, providing the justification for an earlier-than-anticipated cash rate reduction.

The RBA had hoped its latest cash rate cuts in June and July would boost consumer sentiment, drive down unemployment and lift inflation closer towards its target band of 2-3%.

But according to Mr Evans, there are little signs of the two cuts having this effect.

“We have been surprised by the response of consumer sentiment to the rate cuts in June/July, having fallen by nearly 5%,” he said.

“Furthermore, our measure of unemployment expectations has also deteriorated markedly.

“Our forecasts of inflation and unemployment emphasise the extent of the challenge faced by the RBA in boosting demand and wages and reaching their own targets.

“We expect that the RBA will eventually see only one more rate cut, in October, as being an insufficient response.”

Unemployment rate – The RBA’s challenge

RBA Governor Philip Lowe has stated his desire to see Australia’s unemployment rate fall to 4.5%.

This appears a challenge, given the current rate of 5.2% which isn’t showing signs of falling anytime soon.

According to Mr Evans, Westpac’s own forecast is for the unemployment rate to increase to 5.4% by the end of 2019.

“A range of our leading indicators – the Westpac Jobs Index and the Westpac Index of Unemployment Expectations – signal a continuation of the current slowdown in employment growth over the remainder of 2019 and into 2020,” he said.

“With the unemployment rate holding or drifting higher there seems little justification to delay the cut to 0.75% to November.”

Will banks be able to pass on any more rate cuts?

With many savings account and term deposit rates already approaching 0%, further cash rate cuts are likely to become harder for banks to pass on to home loan customers.

Many banks, particularly smaller customer-owned institutions, rely on customer deposits via savings accounts and term deposits to provide them with the funds to offer home loans.

To be able to afford to pass on a home loan rate cut, such banks typically also cut the rates of interest they pay out to savings account and term deposit customers.

But with an increasing number of banks now only offering savings account base rates of less than 0.25% p.a., there’s less interest to cut from these deposit rates for banks to afford to pass on future cuts to home loans.

Mr Evans said the response of the banks to the next cash rate cut would provide an indicator to the RBA of the effectiveness of any further cuts.

But according to Mr Evans, the RBA could encourage banks to pass on cash rate cuts to home loan customers by adopting a funding scheme package similar to the one adopted by the Bank of England in the UK when it cut its cash rate from 0.5% to 0.25% in June 2016.

“The Term Funding Scheme allowed banks to borrow from the Bank of England on a secured basis at the new Bank Rate,” he said.

“Adopting a package of instruments, alongside a cut in the Bank Rate, ensured the effectiveness of the rate cut and avoided the confidence drag from adopting an ’emergency measure’ later on, such as a term lending program or asset purchase facility in isolation.”

However, Mr Evans said the response to the next rate cut may be enough to encourage the RBA to cut again without the use of such a package.

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