Reserve Bank goes for growth: CommSec's Craig James

Reserve Bank goes for growth: CommSec's Craig James
Reserve Bank goes for growth: CommSec's Craig James

GUEST OBSERVER

The Reserve Bank has cut the cash rate from 2.00 percent to a record low of 1.75 percent.

The Reserve Bank has now adopted a “neutral stance” – suggesting that interest rates are on hold until at least the next reading of inflation (the next three months).

What does it all mean?

When the Reserve Bank cut the cash rate to 2.00 per cent in May last year, banks cut variable housing rates from 5.65 per cent to 5.45 per cent. In the period since banks were forced to lift housing rates to partially fund the cost of higher bank capital ratios. The average bank variable rate was back at 5.65 per cent before today’s decision.

 

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Reserve Bank goes for growth: CommSec's Craig James

At the same time, the Aussie dollar had fallen from US78 cents over the past year to US76-77 cents and the oil price has fallen from US$60 to US$45 a barrel. So monetary policy settings were only a little more accommodative before today’s rate decision.

It may sound like a broken record, but the Reserve Bank has to be forward-looking in setting interest rates. And in so doing, today it saw little risk in cutting rates further. It would have been a different situation if the global economy was going gangbusters and if there wasn’t a structural global trend to lower inflation.

In short, consumers can buy goods wherever and whenever they want to and this is causing businesses across the world to keep prices low.

It is important to note that the Reserve Bank is cutting from a position of strength rather than weakness. The economy is growing at a 3 per cent annual rate, unemployment is at 5.7 per cent and underlying inflation is below 2 per cent. So there is firm growth and low inflation. The Reserve Bank believes that the economy can do even better. And that is something that should inspire confidence across the economy.

The Reserve Bank has made no secret of its desire for a lower Aussie dollar, saying it “may complicate” the adjustment process for the economy. Clearly, if the Aussie dollar was a lot lower it would be providing more stimulus to the economy and helping to do some of the “heavy lifting” done by monetary policy. The good news is that the Aussie fell from US77.2 cents to US75.55 cents after the rates decision.

Perspectives on interest rates

The Reserve Bank cut the cash rate by 25 basis points (quarter of a percent) to 1.75 per cent. The previous rate cut was in May 2015 (25 basis points), taking the cash rate to a record low of 2.00 per cent.

There have now been 11 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 today’s decision?

The Reserve Bank will update forecasts for economic growth and inflation on Friday. The growth forecasts may be revised up a touch; inflation, revised down a touch. The Reserve Bank will now stay on the monetary policy sidelines until the next inflation data.

If inflation continues to undershoot the 2-3 per cent target band, the Reserve Bank will keep interest rate cuts on the table. If the RBA feels that low inflation is a global, structural issue rather than driven by short-term economics, then there are fewer risks in cutting interest rates.

The big question is whether the economy still responds in the same way to rate cuts – that is, with rates so low – at generational lows. That is the $64 question.

The following table shows current monthly repayments on a range of mortgages and projections if rates are cut by major lenders in response to the lower cash rate.

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Reserve Bank goes for growth: CommSec's Craig James

 Craig James is the chief economist at CommSec.

Craig James

Craig James

Craig James is the Chief Economist at CommSec, interpreting ‘big picture’ economic and financial trends.

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Interest Rates

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