The Reserve Bank Board has cut the cash rate for the first time in 31 months. The cash rate was trimmed by 25 basis points (quarter of a percent) to an 18-month low of 4.50 per cent. The next meeting is on December 6 2011.
In response to lower-than-expected inflation, the Reserve Bank concluded that there was scope to ease financial conditions. If passed on by banks, repayments on a $300,000 mortgage will fall by $49.10 a month.
What does it all mean?
This is clearly the best news that many people have had in quite a while. The past year has seen the worst floods and cyclones in a generation, a European debt crisis, rising power and water bills and a rash of industrial disputes. So a rate cut will be warmly greeted by consumers and businesses alike. We are pleased that the Reserve Bank rejected its inherent conservatism, listened to the concerns of Australians, and delivered an early Christmas present.
It is important to stress that the Reserve Bank is cutting rates from a position of strength, rather than weakness. The RBA can cut rates simply because inflation is under control, inflation is expected to remain under control and because financial conditions were a little too tight given the favourable position of inflation.
Effectively the Reserve Bank has admitted that it got it wrong. In August the Reserve Bank was set to hike rates. But it has become abundantly clear that inflation was under control and financial conditions were tighter than necessary.
Looking across the Four Financial Indicators (FFI) over the past month, it is clear that financial conditions have tightened. Dwelling prices continue to fall, the Australian dollar rose by US10 cents and 3-year swap rates have lifted almost 50 basis points. However credit growth lifted modestly over the past month. Overall, if the Reserve Bank hadn’t cut rates, consumers and businesses would have experiencing more challenging conditions.
While rates have been cut, no one should expect a follow-up move any time soon. This rate cut may be similar to the reduction made in December 2008 – the only interest rate changed delivered in a 27-month period. Certainly the November rate hike of last year was the only rate change delivered in a 17-month period, so the Reserve Bank isn’t averse to remaining on the interest rate sidelines for an extended period.
The Reserve Bank has signalled that it is more comfortable with economic conditions. The global economy has softened, the terms of trade has peaked and “inflation is likely to be consistent with the 2–3 per cent target in 2012 and 2013.”
The Reserve Bank has now moved back to a more neutral stance – that suggests rates could move either way in coming months. If rates are moving anywhere in the short term, clearly it’s down, rather than up.
Interest rate decision and past cycles
The Reserve Bank Board has cut the cash rate for the first time since April 2009 – the first time in 31 months. The cash rate has been reduced by 25 basis points to 4.50 per cent. The Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent. Before today’s move, there had been only one rate hike in the past 17 months.
In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
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.
Since hitting lows of 4.00 per cent on October 4, 3-year swap rates have lifted to 4.41 per cent.
What are the implications of today’s decision?
For a more detailed explanation of the Reserve Bank’s decision, attention will now shift to the Statement on Monetary Policy, to be released on Friday. This report will contain the Reserve Bank’s latest forecasts on economic growth and inflation.
Investors will need to carefully consider the implications of the rate cut. If banks pass the full rate cut on to borrowers, they are also likely to pass it on to savers in terms of lower term deposit rates. Dividend yields on bank stocks remain attractive, holding near 6.50 per cent, while the property market will receive a boost from the latest rate cut.
The rate cut is especially good news for the beleaguered retail and housing sectors. But even tourism and export sectors receive a boost as the rate cut keeps a cap on the Aussie dollar.