Interest rates: stability reigns

The Reserve Bank Board has left the official cash rate at 3.00 per cent for the fourth straight month. The next RBA Board meeting is on May 7 2013.

The Reserve Bank is becoming more confident of stronger investment outside the mining sector: “While the near-term outlook for investment outside the resources sector is relatively subdued, a modest increase is likely to begin over the next year.” Previously the RBA noted “some prospect of a modest increase” in non-resource investment.

What does it all mean?

• The Reserve Bank has long held the belief that setting interest rates is more art than a science. Well, over the next 3-6 months, the artistic talents of the Reserve Bank will be well and truly tested.
• The Reserve Bank doesn’t want to frighten the horses by flagging rate hikes too early in the piece. But with home prices and share prices lifting and global risks dissipating, the Reserve Bank would also be loath to keep super low interest rates in place too long. It is a matter of finding the right balance, and that especially means find the right wording each month for the accompanying interest rate statement.
• Certainly it is far too early for the Reserve Bank to be getting hawkish, that is, flagging potential rate hikes either later this year or early next year. The easing bias is still appropriate both to highlight the risks that still exist in the global economy and to sustain momentum in the domestic economy.
• CommSec expects that the Reserve Bank will stay on the interest rate sidelines for the next six months. While there is still a risk that the Reserve Bank may have to cut rates again, the risk is fading day-by-day. But it is far too premature to start pencilling in higher interest rates. The current level of interest rates is appropriate for both savers and borrowers.
• In 2009 there was a gap of six months before the last rate cut (to 3.00 per cent) and the first rate hike. In 2001-02, there was a gap of five months before the last rate cut (to 4.25 per cent) and the first rate hike. In 1998-99, there was a gap of 11 months before the last rate cut (to 4.75 per cent) and the first rate hike. And in 1993-94 there was a 13-month gap between the last rate cut (to 4.75 per cent) and the first rate hike.
• If the Reserve Bank was to cut rates in the next few months it would likely be prompted by fresh global turmoil, especially combined with evidence of weaker US and Chinese growth, low domestic inflation and a high Australian dollar.
• An interest rate hike would only be contemplated if there were solid evidence of stronger US and Chinese economic growth, firmer domestic growth, greater confidence of a lift in investment outside the mining sector and greater upside risks for Australian inflation.

Interest rate decision and past cycles

• The Reserve Bank Board has left the cash rate on hold at 3.00 per cent. The previous rate cuts were in December 2012 (25 basis points), October 2012 (25 basis points), June 2012 (25 basis points), May 2012 (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 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 6.45 per cent, below the long-term average or “normal” rate of 7.20 per cent but well above the 41-year low of 5.75 per cent recorded in April-May 2009.

What are the implications of today’s decision?

• Interest rate stability represents a win-win for the economy. That is, borrowers would be more confident to take on more debt when rates are stable, believing opportunities outnumber risks. Depositors would be more open to contemplate moving funds out of cash-based investments into other asset classes such as property and shares.
• Latest figures show that Aussie families, businesses and super funds alike are still over-invested in defensive cash-based investments.
• Aussie home buyers are well ahead in their repayment schedules, giving them confidence to spend in the months ahead.
• Home prices are rising, boosting wealth levels for the two-thirds of Australians either paying off home loans or owning their homes outright. And the good news for renters is that while home prices are rising, affordability still is near the best levels in a decade. Interest rate stability is a positive development for renters, especially as this group tend to be depositors.
• The Reserve Bank is closely watching the housing sector. The RBA noted that “Dwelling investment is slowly increasing, with rising dwelling prices and high rental yields.” Last month the reference was “higher dwelling prices and rental yields.” It is a subtle difference in wording, but worth noting.