• The cash rate has been cut by a quarter of a percent to a record low of 2.25 per cent.

What does it all mean?

• The Reserve Bank Governor has previously revealed that at each Board meeting members ask a simple question: ‘of all decisions that I could make, which would I regret the least?’ For the past 18 months, the cash rate has been held at a 54-year low of 2.50 per cent. At yesterday’s Board meeting members weighed up the options and concluded that the best decision was to cut rates to record lows.
• What has changed since December? Effectively the new global deflationary risk – the Reserve Bank has joined Canada, Europe and Japan in trying to pump up growth in the global economy. The other worry is falling export returns, crimping income growth in Australia. The Reserve Bank believes it needs to counter this by putting dollars in people’s pockets.
• Is the decision risky? Yes, but the RBA believe that it is a risk worth taking with inflation low and the economy growing at a below-normal pace. The risks lie very much in the housing sector as another rate cut will further boost demand for homes and drive up prices. And if the Reserve Bank wants to generate greater growth, it is unlikely to stop at just one rate cut. So the cash rate could very well have a ‘1’ in front at some point in 2015.
• Again super-low interest rates are risky. Not only could they attract more marginal borrowers into property investment. But if the experiment of super-low rates doesn’t work, then there will be less firepower available should a real global crisis develop over the next few years.
• Still, at the end of the day, the only tool in the Reserve Bank kit bag is interest rates. The only other quasi-tool available is so-called “open mouth” operations – constantly encouraging businesses and consumers to spend, invest and employ.
• Another risk in cutting interest rates is that it could have perverse effects. If consumers and businesses worry that rates are “too low” and that rate cuts won’t work in boosting growth, then confidence and spending will both decline.
• It is worth considering some of the latest encouraging economic indicators ahead of the rate decision:
• Dwelling starts are at record highs
• Dwelling approvals are at record highs in trend terms
• Retail trade is up 5 per cent over the year (above the 5-year average of 3.4 per cent)
• Home prices are at record highs, up 8 per cent over the year
• Unemployment has fallen for two months
• Job advertisements have risen for seven straight months
• In short, there were good reasons to suggest that the Reserve Bank could have been more patient and stayed on the interest rate sidelines.
• In the latest commentary, the Reserve Bank acknowledged the housing risks: “The Bank is working with other regulators to assess and contain economic risks that may arise from the housing market.”
• On the Aussie dollar, the Reserve Bank said “The Australian dollar has declined noticeably against a rising US dollar over recent months, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy.”
• With interest rates at historic lows, investors will need to closely assess investment returns, weighing up the risk/reward equation. If investors blindly keep their funds in cash-based investments then they could find themselves slipping even further behind the cost of living.
• The Reserve Bank will closely assess domestic and global economic and financial developments in coming months to determine if rates do need to be reduced further. The focus now is the Statement on Monetary Policy on Friday, especially the latest economic and inflation forecasts. If the Reserve Bank determines that there is a real risk that inflation would under-shoot the 2-3 per cent target band then the Reserve Bank wouldn’t hesitate to cut rates again.
• The key to future moves in interest rates is the job market. If employment continues to improve and wage growth lifts to more “normal” levels then the Reserve Bank will change monetary policy back to a more neutral stance.
• The “easing bias” for interest rates will keep downward pressure on the Aussie dollar. While positive for exporters, manufacturers and businesses generally, the lower Aussie dollar tends to depress consumer confidence. If sustained, the lower Australian dollar will lead to higher prices for imported goods and therefore higher prices.
• Financial markets are factoring in a cash rate of 2 per cent in six months’ time and they could very well be right.

What are the implications of yesterday’s decision?

• With interest rates at historic lows, investors will need to closely assess investment returns, weighing up the risk/reward equation. If investors blindly keep their funds in cash-based investments then they could find themselves slipping even further behind the cost of living.
• The Reserve Bank will closely assess domestic and global economic and financial developments in coming months to determine if rates do need to be reduced further. The focus now is the Statement on Monetary Policy on Friday, especially the latest economic and inflation forecasts. If the Reserve Bank determines that there is a real risk that inflation would under-shoot the 2-3 per cent target band then the Reserve Bank wouldn’t hesitate to cut rates again.
• The key to future moves in interest rates is the job market. If employment continues to improve and wage growth lifts to more “normal” levels then the Reserve Bank will change monetary policy back to a more neutral stance.
• The “easing bias” for interest rates will keep downward pressure on the Aussie dollar. While positive for exporters, manufacturers and businesses generally, the lower Aussie dollar tends to depress consumer confidence. If sustained, the lower Australian dollar will lead to higher prices for imported goods and therefore higher prices.
• Financial markets are factoring in a cash rate of 2 per cent in six months’ time and they could very well be right.

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