Reserve Bank keeps powder dry

Reserve Bank Board meeting

• The cash rate has left at a record low of 2.25 per cent. The door has been left open to another rate cut.

What does it all mean?

• Rate cut or no rate cut, interest rates have never been lower. Looking out across the yield curve to 10-year swaps (10-year fixed rate loans for business), arguably interest rates haven’t been this low. Perhaps if you went back to the early 1950s you could find lower rates, but there wasn’t the raft of borrowing options.
• The key question is whether low interest rates still have a role to play in boosting economic growth. And this is a question that the Reserve Bank Board is seriously discussing. Minutes from the March Board meeting show:
• “Members discussed the extent to which accommodative monetary policy and ongoing strength in housing market activity would support consumption growth in the near term. They noted that the interest payments made by borrowers are significantly larger than the income received by holders of interest-bearing assets and, as a result, the very low level of interest rates was acting, other things equal, to support aggregate disposable income available for consumption. Members noted that the net effect on consumption through this transmission channel was a function of a number of factors, including the distribution of loans and interest-bearing assets across households and the extent to which the consumption behaviour of different households responds to low interest rates.”
• It’s always important to note that while there are still economy-wide benefits from cutting interest rates, some groups are actually made worse off when the Reserve Bank cuts the cash rate. The National Centre of Social and-Economic Modelling (NATSEM) have estimated that households where occupants are over 65 years of age, were actually $29 a year worse off as a result of the February rate cut. And NATSEM note “Overall, 54 per cent of households gain from a reduction in interest rates. Around 45 per cent are worse off and one per cent is not affected.”
• The Reserve Bank didn’t cut rates today because it had no reason to – there was no “smoking gun”, no urgency to cut rates again. In fact today’s economic data may have prevented a rate cut at the 11^th hour. Retail spending was robust in February and the March new car sales figures were the strongest for any March month. These are hardly the statistics of an economy struggling.
• There were few changes in the wording of the statement – eight short paragraphs. One interesting change was on the Aussie dollar: “Further depreciation seems likely, particularly given the significant declines in key commodity prices.” CommSec expects the Aussie dollar to be at US70c at the end of the year.

Perspectives on interest rates

• The last rate cut was in February 2015 (25 basis points), taking the cash rate to a record low of 2.25 per cent.
• There have been nine rate cuts since November 2011.
• 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.

What are the implications of yesterday’s decision?

• Has the Reserve Bank finished with cutting rates? Whilever inflation is contained and the economy is growing at a slower than “normal” pace, the Reserve Bank will keep interest rate cuts on the radar screen. But it will also step up its research to ensure that rate cuts don’t end up having perverse effects on the economy – that is, causing people to lose confidence and stop spending.
• As we stressed last month, the fundamental factor holding back the Australian economy is confidence. Broadly, so-called economic fundamentals remain favourable. Inflation is low, interest rates are low, the budget deficit is still only around 2.5-3.0 per cent of GDP and home building is at record highs. Consumers and businesses just need more confidence to spend, invest and employ. And ultimately that requires our politicians to work constructively for the good of the nation. If it requires compromise to achieve agreement and thus defuse damaging conflicts, then so be it.
• CommSec expects that rates will fall one last time – a quarter of a percentage point reduction in the cash rate to 2.00 per cent in May. At the May Board meeting the Reserve Bank will have the latest data on inflation, another set of jobs figures, and more information on how home prices are tracking.
• There is no rush. The Reserve Bank would like to help the economy along with more stimulus because growth is below “normal”. But it must be confident another rate cut would do some good, not harm the economy.