Pressure mounts on RBA to cut interest rates after US Federal Reserve drops cash rate by 0.5 per cent

The Reserve Bank of Australia (RBA) is set to come under increasing pressure to cut interest rates after a major country finally slashed the official cash rate for the first time since 2020. The US Federal Reserve nearly unanimously voted to reduce the federal funds rate by 0.5 percentage points to a range of 4.75 to 5 per cent.

This ends a rate held since July last year that was a 23-year high. The Federal Reserve is also tipped to cut rates two more times by Christmas, four more times in 2025 and twice again in 2026.

Economist and Yahoo Finance contributor Stephen Koukoulas said the writing was on the wall for the United States to end its inflation-fighting campaign.

"Slower growth, a softer labour market and an outlook of well-contained inflation have set the scene for interest rate cuts... with investors 'pricing in' a total of around 150 basis points of cuts in the US over the next 18 months or so," he wrote in an op-ed.

Koukoulas added that what the US does has "an important influence on what the Reserve Bank of Australia will do with our interest rates".

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Why did the US Federal Reserve cut rates?

The Federal Reserve noted in its decision to bring down the federal funds rate that it had "greater confidence" that inflation was moving "sustainably" towards its 2 per cent target.

"The risks to achieving its employment and inflation goals are roughly in balance,” the Fed added.

Chairman Jerome Powell noted the current level of inflation of 2.5 per cent, which is the lowest since February 2021 and massively down on the peak of 9.1 per cent in June 2022, was encouraging but they will keep a close eye on the number for future rate cuts.

“We can go quicker if that’s appropriate, we can go slower if that’s appropriate, we can pause if that’s appropriate,” he said in a press conference after the two-day meeting.

When asked by Yahoo Finance about the economy's vulnerability to a shock that could cause a recession, Powell said he doesn't see "anything in the economy right now that suggests that the likelihood of a downturn is elevated".

The Federal Reserve's decision to cut rates brings it in line with other major nations including the European Union, the UK, Canada, New Zealand, Denmark, Switzerland, China, and many others.

Powell believes that waiting longer to reduce the federal funds rate compared to other nations has "really paid dividends" as it allowed policymakers to get more comfortable about the downward path of inflation.

All eyes will be on whether the RBA will follow suit

RBA governor Michele Bullock has already stated that Australia's central bank won't be swayed by other nations cutting rates.

"At the moment, interest rates in the United States are higher than us. We've been criticised for that, in fact," she said last month.

"We've been criticised by some people saying our interest rates should be... near where the United States ones are. But we've chosen... very deliberately to try and bring inflation down while not turning the economy into a recession and spiking unemployment.

"That's been our strategy."

The central bank has been insistent that rates won't start to fall until inflation drops into the 2 to 3 per cent target zone.

Annual trimmed inflation, which is the average rate of inflation and removes the impact of temporary or irregular price changes, was 3.8 per cent in July, down from 4.1 per cent in June.

But, US decisions still play an important role in Australia.

The Fed's move could have an effect on the US dollar and Bullock noted that America's interest rate has been "keeping our dollar a little bit lower".

"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 added.

"At the moment, everyone had increased their interest rates coming out of the pandemic so we didn't really get much action from the exchange rate. But over the next while, as different countries go different ways, it is going to come back into play."

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