The Reserve Bank Board has left the cash rate at 4.75 per cent for the 10th straight month (covering nine formal meetings) – the most stable period for rates in five years. The next meeting is on October 4 2011.

The main change in the accompanying statement is the more downbeat comments on the global economy. Anyone pinning their hopes on a rate cut would be focussing on the environment outside Australia.

What does it all mean?
There is no suggestion that the RBA is closer to cutting rates, but it certainly isn’t envisaging hiking rates any time soon. But no one should doubt the benefits conveyed by interest rate stability. This is the most stable environment for rates in five years, meaning that consumers and businesses should forget about rates and get on with life.

Whichever way you cut it, financial conditions are tight. Housing interest rates are above long-term averages, the Aussie dollar is up 15 per cent over the year, home prices are falling and credit is recording the weakest growth in 20 months. Given the softness in the domestic economy and huge risks in Europe and the United States, the question is whether financial conditions will need to be eased in coming months.

If the Aussie dollar was to fall substantially that would provide tremendous relief for exporters, manufacturers and the tourism sector. Consumers would also re-consider on-line purchases, perhaps spending money at home instead. And travellers would also re-consider plans to holiday abroad, keeping more money inside the country. However if the Aussie dollar remains persistently high, the Reserve Bank may need to give serious thought to cutting rates. Much depends on the turmoil abroad and movements in our currency.

Inflation clearly isn’t a problem currently. Fruit and vegetable prices have started falling after the flood-induced lift to prices earlier in the year. At the same time, petrol prices are trending sideways and retailers are heavily discounting to move stock. The latest TD Securities-Melbourne Institute gauge of 1,000 prices across the economy shows that underlying inflation is at 7-year lows. Clearly that result makes sense in light of the softness of consumer and business spending.
 
Our central view is that the Reserve Bank won’t touch official interest rates over the remainder of 2011. But it is obvious that if rates are to move in any direction in the next few months, it is down, not up, as is clearly indicated by financial market pricing. The Reserve Bank Governor is sitting and watching, having noted recently, “At times of extreme turbulence it is often a good idea to sit still as a kind of tactical thing.”

Interest rate decision and past cycles
The Reserve Bank Board has left the cash rate at 4.75 per cent for the 10th straight month. In October 2009 the cash rate stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April, May and November 2010. There has been only one rate hike in the past 16 months.

In the last rate-cutting cycle the cash rate fell to a low of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
In response to funding pressures, banks were forced to lift rates above the cash rate. As a result, the Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.80 per cent, well above the long-term average or “normal” rate of 7.15 per cent.

Financial markets have fully priced in a 25 basis point rate cut over the next two months. Two rate cuts are priced in over the next four months. And three rate cuts are priced in over the next nine months.

The good news for business borrowers is that 3-year swap rates are less than one percentage point away from the all-time lows recorded in February 2009.

What are the implications of today’s decision?
The focus now shifts to a speech by the Reserve Bank Governor in Perth tomorrow and a speech by Assistant Governor Philip Lowe on September 22. Globally, key events are a speech by US President Obama on Friday and the next Federal Reserve meeting on September 20/21.

There is no relief for retailers or the housing industry. So short of a marked improvement in the global economy, or well crafted stimulus measures in the US, there is no apparent near-term circuit-breaker to get consumers out of their funk. Consumers are likely to remain wary and price-conscious, keeping pressure on retail prices, margins and profits. For the past five years, retail sector profits have fallen in real terms and no short-term improvement is likely.