The Reserve Bank Board has cut official rates for the second consecutive month, trimming the cash rate by 25 basis points (quarter of a percent) to 4.25 per cent. The last time the Reserve Bank cut rates at consecutive Board meetings was February 2009. The next meeting is on February 7 2012.
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 $48.65 a month.
What does it all mean?
- With the peak auction season completed, the rate cut comes too late to help the housing market in 2011. But it is certainly the tonic to kick off the New Year in fine style. The housing market is becalmed at present, but 2012 should be a different story. Rates are down, prices are flat or falling, the job market remains healthy and the rental market is tight. All the preconditions are in place for stronger housing demand and higher prices in 2012.
- While too late for housing, the rate cut isn’t too late for retailers. The rate cut should drive more shoppers into the stores with Aussie consumers more determined to enjoy themselves this year.
- There were certainly ample reasons to justify the rate cut. Inflation is under control, the job market is slowing, consumers refuse to spend or borrow and home buyers are choosing to stay on the sidelines. The only question for the Reserve Bank was whether to cut rates now or wait and see how the euro situation played out and move in 2012 instead. In the end the Reserve Bank opted to take out some insurance.
If there were just domestic considerations for a rate cut, then the Reserve Bank may have held off on a decision to cut rates until next year. But the justification for a rate cut was compelling in terms of both domestic and global factors. Not only does Europe look to be headed for recession, but Chinese authorities will have to resuscitate their flagging economy. - So where do we go from here? Even if banks pass on the rate cut, lending rates will still be slightly above “normal”. That is, interest settings are still slowing the economy modestly. But there are other factors to consider – the exchange rate is still high, credit growth is weak and home prices are falling. So arguably interest rates need to fall further to offset other financial indicators that aren’t providing the economy with much assistance at present.
- The Reserve Bank has made it abundantly clear what it considers “normal” interest rates – the average level of rates over the past 15 years. The mortgage rate has averaged 7.20 per cent over the past 15 years. If banks pass on the rate cut in full, then the mortgage rate will be 7.30 per cent – still a little on the high side.
- CommSec is factoring in another quarter per cent rate cut in February. Clearly with inflation under control and significant risks abroad, the Reserve Bank stands ready to cut rates and shore up Australia’s economy.
Interest rate decision and past cycles
- The Reserve Bank Board has cut the cash rate for the second straight month. The cash rate has been reduced by 25 basis points to 4.25 per cent following a similar 25bp cut in November – the first in 31 months. 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.
- 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 7.55 per cent, still above the long-term average or “normal” rate of 7.20 per cent.
What are the implications of today’s decision?
- Investors will now have more choices. The question is whether they stay with term deposits or move back into the share or property markets. If banks cut mortgage rates, they may in turn cut term deposit rates. But arguably investors would get healthy full-franked dividends in the sharemarket. And there are likely to be attractive propositions in the housing market after today.
- “Forgotten” parts of the sharemarket will now come back into focus such as the Consumer Discretionary sector – companies like clothing and department stores. Consumers have got reason to spend again with the two rate cuts largely offsetting rising utility costs. Certainly there are few other negatives for consumers as food, clothing, cars and household goods have been getting cheaper, not dearer.
- Today’s rate cut provides opportunities for businesses, consumers and home buyers. Over the past year most people have focussed on the risks and as a result spending, investment and hiring have proved sub-standard. Now is the time for Australians to become confident again.