US cuts interest rates by 0.5%: What does it mean for Australia?

Scott Kuru September 19, 2024 4 min read

Image by Al Drago/The New York Times via AP, Pool, File

KEY POINTS

The US Federal Reserve cut interest rates by 0.5%, the first in over four years
US rates had hit two-decade highs to combat inflation
Global rate cuts could help lower Australian inflation, prompting earlier RBA action

America’s central bank has slashed interest rates, in a move that could have implications for Australia.

The decision by the US Federal Reserve to cut interest rates by half a percent (0.5%) could help ease inflation in Australia, paving the way for interest rate cuts here sooner.

The details

The US Federal Reserve has moved to cut America’s cash rate by half a percent, taking the country’s target federal funds range from 5.25%-5.5% to 4.75%-5%.

It’s the bank’s first interest cut in more than four years and given that interest rates were at their highest point in two decades, the move is being seen as a sign that America has won the fight against an inflation breakout.

Inflation peaked at 9.1% in June 2022 and has since fallen back to around 2.5%.

The Fed Reserve uses interest rates as its main tool to try to keep American inflation at 2% or less.

“Our patient approach over the past year has paid dividends,” the Fed Reserve Chairman Jerome Powell said after the decision was announced.

“Inflation is now closer to our objective, and we have gained greater confidence that inflation is moving sustainably toward 2%.”

A rate cut was widely expected, but market traders were divided on whether it would be a smaller 0.25% cut, not a “super-sized” 0.5% reduction.

The move by the central bank shows officials are worried about rising unemployment in the world’s most powerful economy, although Mr Powell stressed he didn’t believe a recession was likely.

“I don’t see anything in the economy that suggests the likelihood of a downturn is elevated,” he said.

The Fed Reserve decision means the US joins the European Union, Britain, Canada, New Zealand, Denmark, Switzerland, China, and a number of other countries who’ve recently cut rates.

Implications for Australia

The decision by the US Federal Reserve—coming on the back of similar moves by other central banks—will put pressure on the Reserve Bank of Australia to consider rate cuts earlier.

The RBA lifted Australia’s cash rate to a 12-year high of 4.35% in November last year, its 13th straight hike since May 2022, in a bid to dampen runaway inflation.

Since then the RBA Governor Michele Bullock has tried to dampen expectations of rate cuts, despite the fact Australian inflation is trending down towards the central bank’s 2-3% target range.

After the board’s last decision to keep rates on hold in August, Ms Bullock said it was unlikely the RBA would cut rates in “the next six months.”

However, coordinated rate cuts by central banks in the world’s most powerful economies—including the US—could force the RBA’s hand.

If it leaves the cash rate too high for too long, Australia could tip into a recession.

Peter Martin, the Visiting Fellow at the Crawford School of Public Policy at the Australian National University, has been predicting the RBA will start cutting rates in November at its meeting on Melbourne Cup Day.

Martin, who’s also the Economics Editor of The Conversation, has said he believes the Australian dollar will climb on the back of lower US interest rates.

“This is because cuts in the US make the US a relatively less attractive place to hold money and Australia a relatively more attractive place.”

“The more the Australian dollar climbs relative to the US dollar, the cheaper the imports that are priced in US dollars become – which is another way of saying the lower Australian inflation becomes,” he explains.

“It’s the same for other countries,” he says.

“Merely by cutting their own rates, the US and other countries will be easing inflation in Australia.”

“The more they do it, the more Australian inflation will ease, building up a stronger and stronger case for our Reserve Bank to cut rates.”

RBA Governor Michele Bullock also admitted last month that rate cuts in the US would be a useful tool in bringing inflation in Australia down.

"If the interest rates in the US start to decline, which people are expecting, that will probably give a bit more support to our exchange rate,” she said.

"At the moment, everyone had increased their interest rates coming out of the pandemic so we didn't really get much action (in fighting inflation) from the exchange rate.”

“But over the next while, as different countries go different ways, it is going to come back into play."

Financial traders - who bet millions of dollars each day on interest rate futures - have been largely ignoring Michele Bullock’s pronouncements that it would be premature to start thinking about rate cuts in the next six months.

They’ve fully priced one 0.25% rate cut by February, three by May and a fourth - for a total of 1% - by August 2025.