Between rocks and a soft place - what the recent rate cut means

Between rocks and a soft place - what the recent rate cut means

I would have loved to have been a fly on the wall of this months’ R.B.A rates decision to CUT the official cash rate down to a record low of 1.5% p.a as no doubt there would have been some interesting discussions at the meeting. 

I genuinely feel for the R.B.A.   While the Aussie economy is actually not in bad shape with the most recent GDP growth rate beating market expectations to come in at an annualised 3.1% p.a (http://www.rba.gov.au/snapshots/economy-snapshot/) and the R.B.A has unemployment as holding steady at 5.8%. The 2 big white elephants in the room remain: the stubbornly low inflation rate (1% p.a) and the seemingly unsinkable Aussie Dollar (around US 75c).

Australia is seems is really between the rocks (the slowdown in the mining boom and Australia’s subsequent shift away from being dependent on digging up rocks from the ground to a more broad based service based economy) and a soft place (the majority of advanced economies are battling deflation and low G.D.P growth). 

Really the R.B.A’s domestic policy will have little influence over what happens next. Australia, despite being the worlds 13th largest economy (by nominal GDP), is only the 53rd largest by population.  It is therefore both too small economically to embark on a major money printing exercise (QE) or attempt to have a currency war with the big boys (U.S, China, Japan & Eurozone).

Before the rate cut, just over half (23 of the 41) of the experts surveyed by financial comparison website finder.com.au believed that the Reserve Bank would, in fact cut the official cost of borrowing yesterday. We will now have to wait for the full board meeting minutes to see just how close this call was for the R.B.A. members.

But what does that now mean for Australia, and Australians? Well it depends on who you are and what you are trying to achieve?

At the end of the day, dropping rates is a clear cut sign that the Australian economy (like many other advanced and emerging economies) is facing some significant challenges right now.

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It is undoubtedly bad news for SAVERS or RETIREES many of whom have seen their returns decimated over recent years. This has seen many people dependent on fixed, or interest rate returns being forced into RISKIER asset classes just to get by. I genuinely fear for those who have worked hard their whole life, investing and saving for a certain level of retirement only to see the rest of the world seemingly conspire against them with massive Quantitative Easing, Currency Wars, and Ultra-Low Interest Rates. 

However, what is not at all clear is exactly how the markets will react to the news of further rate cuts. The banks have already decided to only pass on a fraction of the cut to borrowers as they basically say "screw you” to borrowers in favour of maintaining profit margins to benefit share holders.  

But the bigger question is will any rate reduction be enough to get businesses and consumers off the fence. They have been sitting on the sidelines so long now that they are starting to look like professional bench warmers. But who can blame them when profits and incomes are being downgraded all around the world. I doubt that a further 0.5% (or less) cut will be enough for businesses or consumers to get back in the game in any big way and take advantage of these all time low rates to borrow more money? On the flip side, will this rate cut just further rattle consumer confidence and lead to even lower inflation numbers for the R.B.A to deal with in the months, years, or even decades ahead?

Let’s quickly explore the possible thought processes and the economic data behind this months R.B.A decision:

1.   INFLATION: Weighing heaviest on the R.B.A’s decision was perhaps the stubbornly low inflation rate. The June Quarter saw a headline inflation of 0.6 and annualised inflation of just 1.0 %p.a. Excluding volatile items sees the annualised inflation figure for June a little better at 1.6%, but this is still below the R.B.A's target band of 2-3% p.a giving them scope to cut rates.

2.   EXCHANGE RATE: The AUD has been trading uncomfortably high for the R.B.A at around US 75c prior to this rates anmouncement. However, no matter what the R.B.A does, overseas forces will probably have a bigger impact on the AUD. Weaker than expected preliminary 2nd Quarter US GDP figure of just 1.6% against analysts expectations of 2.6%, and movements of the Yen, have kept the AUD higher than ideal for Australia's export driven economy. However, if PMI data out of from China (due out tomorrow) disappoints, then the R.B.A will be hoping that this rates cut could just be enough of a catalyst to see the AUD dropping lower. 

3.   LENDING & HOUSING: Last years’ changes from the Australian Prudential Regulatory Authority (APRA) have had an impact on investor lending rates and conditions and the cooling housing market is obviously now not a major concern for the R.B.A given this rates decision (or the property market is at least the lesser of a few evils). Unlike the last cut which saw lenders pass the cuts on in full, the C.B.A have already announced that they will only be cutting lending rates for standard variable rates by just 0.13%. This will take the standard variable rate for owner-occupiers to 5.22 per cent. 

4.   EMPLOYMENT: The unemployment rate has been largely steady at around 5.8% but the R.B.A may be concerned about potential job losses moving forward caused by the winding up of some manufacturing jobs such as the automotive industry next year and a clearly deflationary funk laying over the global economy.

 

 

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