Why Reserve Bank may not be able to cut interest rates even if Australia falls into a recession

The Reserve Bank won’t be able to cut interest rates even if Australia falls into a recession and house prices plunge, a leading economist fears.

The futures market sees no prospect of a rate rise on Tuesday next week, with unemployment already at a four-year high of 4.5 per cent in April.

Among the big four banks, NAB on Tuesday became the first to signal the next move from the RBA would be a cut to the existing 4.35 per cent cash rate.

But HSBC chief economist Paul Bloxham said the Reserve Bank would be unable to cut rates, even if the economy went backwards in the June quarter and possibly too in the September quarter, which would mark Australia’s first technical recession since 1991 caused by higher interest rates.

“I don’t think the RBA’s going to be able to sweep in and cut interest rates any time soon like often they do in the face of a downturn,” he told The Nightly.

Inflation is already at a near three-year high of 4.2 per cent and the Reserve Bank is expecting it to hit 4.8 per cent by the end of this month, which would mark the 11th consecutive month of the consumer price index being above the RBA’s 2-3 per cent target.

This would stop the Reserve Bank slashing interest rates like it did during the COVID recession of early 2020, even as the Middle East war kept crude oil prices elevated.

“Think about previous cycles: often when the economy weakness and if it weakens about as much as we’ve seen, often the RBA sweeps in and is able to cut interest rates and it provides the circuit breaker that gets the economy to turn around,” he said.

“On this occasion, I don’t think they are going to be able to do that very soon because they’ve still got an inflation challenge.”

HSBC is predicting a 0.1 per cent drop in gross domestic product during the June quarter, with a follow-up contraction in the three months to September 30 regarded as a “growing risk” that would mean a technical recession.

The bank is predicting flat house price growth in 2026 but sharp falls in 2027, including up to 8 per cent next year in the hot markets of Brisbane and Perth.

This would occur under Labor’s plan to restrict negative gearing to brand new homes from July 2027 as the 50 per cent capital gains tax discount was replaced with a 30 per cent tax on inflation-adjusted gains.

“The Budget has shifted quite a lot of tax policy around the housing market which we think will take quite a lot of investor demand out of the housing market,” Mr Bloxham said.

Former Reserve Bank economist Zac Gross, who is now a senior lecturer in economics at Monash University, said unemployment would have to rise above 5 per cent for the first time since the pandemic for a rate cut to even be considered.

“For there to be a cut, we’d probably need a slowing of the labour market,” he said.

“If we saw that sort of shift in the data, that would certainly take hikes off the table and put a cut as a more likely alternative.”

Any increase in the unemployment rate in May would put it above a level considered full employment, where job seekers are able to find work.

Independent economist Saul Eslake, who is forecasting an August rate hike, said economic contraction in the June quarter and a fall in inflation would be needed for the Reserve Bank to reconsider the need for any rate hike.

“If it looks as though there’s going to be negative growth in the June quarter, then the Reserve Bank probably won’t raise rates again,” he said.

The halving of fuel excise to 26.3 cents a litre, expiring at the end of this month, has also possibly boosted consumer spending by taking petrol prices back to where they were in February before the US strikes on Iran.

“We might see an increase in underlying inflation if people are continuing to spend the money that they’d got,” Mr Eslake said.