Perhaps Philip Lowe should be the next appointment to the U.S. Federal Reserve board of governors. The head of the Reserve Bank of Australia (RBA), the Aussie central bank, had several sensible things to say Tuesday after cutting the cash rate to 1.25 percent from 1.5 percent that Fed policymakers should listen to.
“At its core, today's decision was taken to support employment growth and to provide greater confidence that inflation will be consistent with the medium-term target,” Lowe said at the Reserve Bank board dinner Tuesday evening. He dispelled any notion that the cut came because economic growth was slowing. “Rather it reflects the fact that, even with the expected pick-up in growth, the Australian economy is likely to have spare capacity for a while yet,” he said.
This simple acknowledgment of the facts at hand makes the Fed's convolutions in denying this reality look even more mistaken. Having set their agenda of raising rates in concrete last year, then apologizing for being too slow to change, the Fed now seems determined to set its patience agenda in concrete this year.
This in spite of abundant evidence that like Australia, the U.S. is far from meeting its inflation target and has spare capacity in the labor market. Other central banks, especially in emerging markets, have not been so slow to accept these realities.
The Reserve Bank of India is on course to cut its benchmark repo rate this week by 0.25 percent for the third time this year. Not only is inflation running well below its 4-percent target, the latest economic data show a worrying slowdown in activity.
Rate cuts outstripped rate hikes in May for the fourth month in a row in 37 emerging markets tracked by Reuters. The string follows nine months of net rate hikes to counter a stronger dollar, rising inflation and weaker currencies.
Among those cutting rates last month were Asian countries Sri Lanka, with a cut of 0.50 percent in its benchmark rate; the Philippines cut by 0.25 percent as inflation was expected to slow along with the economy; and Malaysia cut by 0.25 percent over worries about global economic growth.
Ukraine trimmed its benchmark rate for the first time in two years, joining other former Soviet republics Azerbaijan, Kazakhstan, Tajikistan, Kyrgyzstan, and Georgia in a round of rate cuts. In Africa, Nigeria, Angola and Rwanda cut rates.
Several countries raised rates. Pakistan hiked rates to combat inflation, as did the Czech Republic and Tunisia, while many others made no change in monetary policy. But the trend among the 22 countries that changed monetary policy remained decidedly in favor of cuts.
St. Louis Fed chief James Bullard, who has been an outspoken dove on the Federal Open Market Committee (FOMC), spurred U.S. markets Tuesday after saying a rate cut might be necessary soon as the standoff on trade is prolonged. Fed chair Jerome Powell fanned the flames when he said Tuesday that the central bank is closely monitoring the trade situation and “will act as appropriate to sustain the expansion.”
The economic risk from escalating trade tensions is no doubt real, and if the Fed wants to use that as an alibi for correcting its previous mistakes of raising rates too quickly, then not reversing them because President Donald Trump was hectoring them to do so, investors won’t complain. Few expect the Fed to reverse course as soon as this month’s meeting, but investors will be looking for further hints of flexibility and less talk of patience.
In the meantime, FOMC members would do well to take some advice from Australia’s Lowe. After patting the bank on the back for adopting a flexible inflation target, the RBA governor added, “This flexibility, however, is not boundless.”
The whole point of a target is to provide a strong medium-term anchor for low and stable inflation, he explained, which is an important precondition to sustainable growth in employment and incomes. Guess what—if inflation stays too low for too long, expectations may move lower and it would become harder to achieve the medium-term inflation goal. QED.
Economists expect the RBA to cut rates at least one more time this year, or perhaps even twice, putting the cash rate at 0.75 percent by the end of the year. Lowe, refreshingly, has no argument with that. “The Board has not yet made a decision, but it is not unreasonable to expect a lower cash rate,” he said. The central bank expects the cash rate to follow market pricing, which would put it at around 1 percent at the end of 2019.