The Reserve Bank Board has cut interest rates by 25 basis points to 2.75 per cent. Equivalent official interest rates were last at these levels in 1959/60.The next RBA Board meeting is on June 4 2013.
The Reserve Bank has adopted the global central bank manta of “doing whatever it takes” to get the economy growing at a faster rate. There are risks in cutting rates to generational lows, but the Reserve Bank believes it is a risk worth taking. The Reserve Bank has flagged further rate cuts saying it has used only “some” of its scope to ease rates further.
What does it all mean?
Has anything changed since the last interest rate decision in May? In broad terms, nothing. If anything, the variables have been more mixed. But it is clear that the Reserve Bank believes that the economy can be growing at a faster rate. It first needed to check inflation data at the end of April. And that data confirmed inflation was under control. With the Aussie dollar still historically high, the Reserve Bank embraced the new manta of global central banks – the need to “do what it takes” to lift economic growth.
No doubt the Board gave serious thought to the question of whether a rate cut would actually prove beneficial or could do more harm than good. The risk is that a rate cut could cause Aussie consumers and businesses to actually become more negative, concluding that the economy was losing momentum and prompting money to be left in the bank rather than spent or invested. But the Reserve Bank believes that this is a risk worth taking.
While “official” interest rates are back to levels last seen in the 1960s, the rates that borrowers actually pay have further to fall. Variable housing rates are still around 60 basis points above the “emergency” levels seen in the global financial crisis. So further official rate cuts remain on the table.
If the Reserve Bank was to cut rates in the next few months it would likely be prompted by confirmation that inflation is contained, further evidence that the Aussie economy was tracking sideways, fresh global turmoil, especially combined with evidence of weaker US and Chinese growth, and a resurgent Australian dollar.
Can we regard official interest rates of around 2-3 per cent as the new ‘normal’? It’s important to remember that both inflation and interest rates held at very low levels over the 1950s and 1960s. So it is possible that we have entered a new era with economic growth around 3 per cent, inflation around 2.5 per cent and interest rates around 2-3 per cent.
Interest rate decision and past cycles
The Reserve Bank Board has cut the cash rate by 25 basis points to 2.75 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 this decision?
The Reserve Bank is taking a risk, but it is a calculated risk. The Reserve Bank believes that this is a new environment where rate cuts don’t spark spending and borrowing booms or higher inflation. In short the mentality is different. Consumers and business are more conservative and are far more cautious about borrowing and spending outside their means. And from a big picture perspective, it always has to be remembered that around a third of people own their homes, a third rent and a third are paying off home loans. So only a third of families will potentially benefit from the rate cut.
We say home buyers ‘potentially’ benefit because not all are paying off variable rate loans. And for the wider economy if home buyers don’t elect to trim repayments then there isn’t a boost to spending or investment. The majority of home buyers have responded to recent rate cuts by electing to pay off loans at a faster rate rather than trim repayments.
Looking ahead there are good reasons to be positive. Consumers are spending again, albeit because there are plenty of bargains around. Home purchases continue to lift – in fact the home loan data to be released on May 13 should show a solid increase in new borrowings.
And the European interest rate cut and US jobs data for April are clearly encouraging. Further we believe that the Australian economy is already powering out of a soft patch, and early data suggests that the Australian economy grew by 1.4 per cent in the March quarter or at an annualised pace of almost 6 per cent.
While consumers and businesses are reluctant to borrow, balance sheets are in very good shape, providing a solid platform for future borrowings and increased spending. The trap many analysts fall into is to focus on debt but neglect assets. Net wealth of Aussie consumers is back near record highs.
