The RBA may have a long way to go if it wants its rate cuts to provide stimulus to the economy, a major bank has said.
Westpac chief economist Bill Evans said for the Reserve Bank to achieve economic stimulus, it will need to move rates below a neutral setting. Evans defined a neutral setting as one that neither stimulated nor cooled down the economy, and said this setting changed as the gap between mortgage rates and the official cash rate changed.
"Since 2007 when the global financial crisis started stressing banks' wholesale funding costs the margin between the official cash rate and the standard variable mortgage rate has widened by around 140bps. That effectively lowers neutral from 5.5% to 4.1%," Evans said.
While Evans said the Bank's current setting was 35bps below neutral, he said previous economic downturns had seen the Reserve drop the cash rate farther below neutral to jolt the economy to life. He noted that the RBA had dropped rates 125-150bps below a neutral setting during the GFC.
"That action might make even the current market expectations of a 100bp cut seem conservative," he said.
Future moves, Evans said, would all depend upon consumers' response to the cuts the RBA has already dealt. Should the economy respond to the Reserve Bank's May cut, no more cuts would be needed, he said.
"The prospect seems remote given the flat response of consumer sentiment to the recent cuts [and] the rise in unemployment expectations," he said.
Evans also pointed to the RBA's confidence that inflation would remain in the Bank's target range over the next year. He said the Reserve was also recognising "chronic weakness" in many sectors of the economy.