The Reserve Bank Board has left the official cash rate at 3.50 per cent for the second straight month.
The variable housing rate is applying modest stimulus to the economy at present at 6.85 per cent, below the 15-year average of 7.20 per cent. The next RBA Board meeting is on 4 September 2012.
The Reserve Bank exhibits a quiet confidence: home prices have firmed “a little”, business lending is recording the “strongest growth for several years” but “the exchange rate, however, has remained high, despite the observed decline in the terms of trade and the weaker global outlook.”
What does it all mean?
The Reserve Bank is clearly now in “wait and see” mode. The European and Chinese economies slowed in late 2011 and early 2012 while the US recovery proceeded slowly. As a result the Reserve Bank cut the cash rate by 1.25 percentage points in the space of eight months.
Now the US recovery is proceeding but “at only a modest pace”. “China’s growth has moderated to a more sustainable pace, but does not appear to be slowing further.” But “the most significant area of weakness continues to be Europe, where economic activity has been contracting and policymakers confront the very difficult task of seeking to put both bank and sovereign balance sheets onto a sound footing, while promoting conditions for improved long-term growth.” So the Reserve Bank is maintaining a watchful stance.
But make no mistake; the Reserve Bank is well prepared to cut rates again if necessary. The global outlook is still uncertain. At the same time the Aussie dollar remains high despite “the weaker global outlook”. And inflation remains low – although the Reserve Bank warns that growth in domestic costs need to keep moderating. Certainly our cash rate is still high compared with other nations at 3.50 per cent, so there is plenty of ammunition available.
A key “hot button” issue is the Aussie dollar which is relatively high, and arguably over-valued. If the Aussie was to keep rising, under-pinned by its newly acquired “safe-haven” status, then the Reserve Bank will be tempted to cut rates again. The central bank warned early in the year that currency strength could lead to a rate response, so the issue is clearly on the radar screen.
At present, the fact that the Reserve Bank is content to stay on the interest rate sidelines is a mark of confidence in current settings. Not only have interest rates been lowered in recent months but there have also been government handouts and petrol prices have eased from highs.
CommSec believes that more rate cuts are possible over coming months and we have pencilled in another quarter per cent rate cut by the end of the year. Hopefully this rate cut won’t be required. That is, European officials act with urgency to stabilise financial markets, the US economic recovery gathers pace, the Chinese economy lifts and Aussie consumers maintain confidence to spend, invest and borrow again.
Interest rate decision and past cycles
The Reserve Bank Board has left the cash rate at 3.50 per cent. The previous rate cuts were in June (25 basis points), May (50 basis points) and November and December 2011 (each by 25 basis points). Prior to those moves 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 per cent 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 variable housing rates of major banks are around 6.85 per cent, below the long-term average or “normal” rate of 7.20 per cent. The RBA notes that “interest rates for borrowers (are) a little below their medium-term averages.” In other words stimulus is still very modest.
What are the implications of today’s decision?
For some consumers and businesses confidence is generated when the Reserve Bank Board decides to cut interest rates. But the fact that the Reserve Bank didn’t cut rates this month arguably should inspire even greater confidence. Inflation is below 2 per cent, unemployment is near 5 per cent, economic growth is the fastest of advanced nations and the Federal budget deficit is continuing to contract. There is plenty to inspire confidence.
But the Reserve Bank will need to be mindful of the contractionary effects of the Australian dollar. The fact that interest rates are on hold may result in the Aussie dollar gravitating higher. Reserve Bank officials undertook subtle jawboning on the currency earlier in the year and a repeat dose may be necessary.
Retailers have reason to be hopeful. Consumers are starting to spend again, buoyed by an array of stimulus measures. The stimulus effects will gradually wear off but if they are replaced by a lift in consumer confidence, then the recovery in spending can continue.
With economic conditions showing signs of stabilising, investors now need to start thinking about longer-term returns rather than focussing on short-term capital preservation.
