The Reserve Bank Board has cut the official cash rate by 25 basis points (quarter of a per cent) to 3.25 per cent.
- The Bank cited global factors as justifying the rate cut: “At today’s meeting, the Board judged that, on the back of international developments, the growth outlook for next year looked a little weaker, while inflation was expected to be consistent with the target. The Board therefore decided that it was appropriate for the stance of monetary policy to be a little more accommodative.” The next Board meeting is on November 6 2012.
- The key question is whether in the current environment a rate cut helps or hurts the economy. The level of bank deposits is approaching the amount of loans outstanding. Further, home borrowers are choosing to pay off loans at a faster rate, rather than spend. Retailers must hope that the global economy continues to improve, giving consumers confidence to spend any additional income rather than save it.
What does it all mean?
- The Reserve Bank certainly had the luxury of being able to cut rates. The budget deficit is being wound back so fiscal policy is contractionary. At the same time inflation is under control and key sectors of the economy are finding it tough such as retailing and manufacturing. So it acted to insulate our economy from weakness abroad.
- But while rate cuts have in the past acted to stimulate activity, the impact on the economy today is more ambiguous. While rate cuts help borrowers, they hurt savers. The number of savers has soared and currently deposits are creeping up to be almost neck and neck with loans. Deposits represent around 90 per cent of loans outstanding, well up from 75 per cent just five years ago. Further only a third of households benefit from a rate cut with a third of families renting while a third of families fully own their homes. The non-home buying public tend to be savers rather than borrowers. So a rate cut will hurt all the families living off interest income.
- The $64 question is confidence. If people don’t have the confidence to spend and instead continue to save and pay off home loans at a faster rate, then the rate cut will have no impact on activity. It is also important to note that it is the level of interest rates that does the hard lifting work in the economy, not the change in rates. Interest rates are already below longer-term averages. And judging by what has happened in previous months, home borrowers are more likely to respond to a rate cut by paying off their home loan at a faster rate, rather than going on a spending spree.
- There is a perception that consumers aren’t spending, and that a rate cut could get people shopping again in the lead up to Christmas. But the latest data shows that Aussie consumers are indeed spending, and at a pace in line with long-term averages. Rather people are spending differently – travelling domestically and overseas more often and buying goods on-line. If retailers want to lift sales, they need to focus on the entire experience of sales and service.
- CommSec is pencilling in another rate cut for November. The Reserve Bank still believes rate cuts act to boost growth and it doesn’t tend to move rates just once. Further, the global environment remains fluky and good inflation data is expected later this month.
Interest rate decision and past cycles
- The Reserve Bank Board cut the cash rate by 25 basis points (quarter of a per cent) to 3.25 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 have for some months been a little below their medium-term averages.” In other words stimulus is still very modest.
What are the implications of today’s decision?
- Aussie consumers will spend, invest and borrow more if they have greater confidence, not if rates are cut. In fact it could be argued that today’s rate cut doesn’t boost activity given that the number of savers in the community is approaching the number of borrowers. If the rate cut causes borrowers to repay loans at a faster rate while savers experience lower interest rate income, then a rate cut could conceivably cut spending power and reduce, rather than lift, spending in the near term. Confidence is required for a longer-term lift in spending.
- The level of interest rate remains low, migration is rising but home construction remains soft. All the ingredients are in place for a housing boom, provided buyers have confidence to act on attractive conditions. Since late May home prices have risen at a near 9 per cent annual rate across the country.
- The Aussie dollar will remain high. While today’s interest rate cut has reduced the Aussie from US103.6c to US103.1c, we question whether the currency will continue to fall. In fact the rate cut may have a perverse impact on the currency if global investors believe that Aussie rates are nearing cyclical lows and judge that the next interest rate move could be up, not down, albeit not until 2013.