For the full picture, download the report – Australian Markets Weekly 22 July 2019.

• Reserve Bank research suggests that the two rate cuts to date will boost growth by 0.25-0.4pp over two years and lift inflation by only 0.1pp over two to three years. Part of the transmission mechanism of lower interest rates is via the cash flow channel, where lower rates boost household income given households are a significant net debtor (liabilities are 201% of annual income versus interest-bearing assets at 93%).
• The transmission of lower interest rates to household cash flows changed during the global financial crisis, with a structural increase in the spread between mortgage rates and the cash rate reflecting higher bank funding costs. Since that break, cash flows have broadly reflected the cash rate and we expect the recent rate cuts will boost household income by about 0.3-0.4%.
• This is helpful considering growth in incomes remains sluggish, but is still only a modest boost. This suggests to us that further stimulus will be needed to lift spending and we continue to factor in another rate cut by November along with fiscal stimulus beyond the legislated personal income tax cuts.

The week ahead – Governor Lowe speaks on “inflation targeting and economic welfare”

• Governor Lowe speaks on “Inflation targeting and economic welfare” at lunch-time on Thursday (1:05pm AEST). We think the governor will highlight that the Reserve Bank’s broad mandate means that it can deliver average inflation of between 2 and 3% “in a way that supports sustainable growth in the economy and that bests serves the public interest”. This flexibility allows the bank to take into account the impact of its decisions on financial stability, as was the case in recent years, and the labour market, where the bank now emphasises the desirability of lower unemployment. Assistant Governor (Financial markets) Chris Kent will elaborate on changes to the committed liquidity facility on Tuesday.
• Internationally, Q2 US GDP on Friday is expected to show a slowing US economy, with the consensus expecting annualized growth of 1.8%, which would be the smallest quarterly increase since 2016. The ECB meets on Thursday, where a 49% chance of a 10bp cut to -0.5% is priced by markets. Draghi’s press conference is likely to signal a dovish outlook and a willingness to enact further stimulus. The new UK Prime Minister and leader of the conservative party will be announced on Tuesday.

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