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Central bank cuts rates to record low 2.5%: the experts respond

The Reserve Bank of Australia today lowered the cash rate by 25 basis points to a record low of 2.5%, saying that while inflation had been on target, the domestic economy had been growing below trend…

Reserve bank governor Glenn Stevens said the bank today cut the cash rate to 2.5%, a record low. AAP Image/Paul Miller

The Reserve Bank of Australia today lowered the cash rate by 25 basis points to a record low of 2.5%, saying that while inflation had been on target, the domestic economy had been growing below trend.

The decision accords with expectations, with many economists predicting a cut today.

“The easing in monetary policy over the past 18 months has supported interest-sensitive spending and asset values, and further effects can be expected over time. The pace of borrowing has remained relatively subdued, though recently there are signs of increased demand for finance by households,” central bank governor Glenn Stevens said in a statement.

Below trend economic growth was expected to continue, as the Australian economy adjusts to lower levels of mining investment, he said.

“The unemployment rate has edged higher. Recent data confirm that inflation has been consistent with the medium-term target. With growth in labour costs moderating, this is expected to remain the case over the next one to two years, even with the effects of the recent depreciation of the exchange rate,” he said, adding that global financial conditions remain volatile and commodity prices continued to decline.

“The Australian dollar has depreciated by around 15 per cent since early April, although it remains at a high level. It is possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy.”

Here are some expert responses to today’s interest rates decision.

James Morley, Professor of Economics at University of New South Wales

It’s no great surprise. I think it is tied to the election campaign in that if they felt they had to cut they would rather do it in August rather than in September just before the election. Central banks never want to be seen bowing to political pressure or influencing voters.

Given the sensitivity about that, it may have affected their timing and in this case further out from the election is a time when they can say they were planning this all along before the election was even called.

While I expected they would cut rates, my recommendation would have been to hold steady. The reason is that monetary policy is already quite accommodative and we are already seeing the effects of this in terms of the dollar depreciating and house prices going up.

This is record low interest rate.

They definitely had scope to cut without there being a big worry that inflation would become unhinged. I think the recent deprecation of the dollar will cause inflation to run at the high end of their target range but that will be temporary.

History has shown with the US for example that there’s a risk if monetary policy is too accommodative that it can create asset price and house price bubbles. As my colleague on the Shadow RBA Board, Warwick McKibbin, has pointed out, it is notable that house prices are going up in a time when the economic outlook is weakening. So what’s fuelling that rise in house prices? It’s hard to see it being anything other than the recent cuts in interest rates. That should not be the main basis of economic growth as we move away from relying on the mining sector playing that role.

The bigger role going forward if there is a big slow down in the economy should be for fiscal policy, but no one seems to be pushing that in the lead-up to the election.

Jakob Madsen, Xiaokai Yang Professor of Business and Economics at Monash University

The RBA’s focus is on inflation, economic growth and unemployment. Inflation is within its target range, economic growth is weaker and unemployment is above the structural unemployment level, so there is definitely some space for an interest rate cut.

The economy is not showing strong growth, it’s below it’s potential and that has been the major thing. The RBA statement says they are a bit concerned about the global economy, talking about volatility in the asset market and global growth but I think the cut today is just a precaution. There is no emergency, despite what the Coalition has said. An emergency is what we saw in 2008 when central bank rates fell by 2.25% in eight months. If you look at the United States and Europe and Japan, the cash rate is very close to zero, or zero. There is nothing extraordinary about the Australian situation.

While the cash rate of 2.25% is historically low and the inflation rate is also at the lowest rate we’ve seen in post-world war 2 period, there is absolutely no sign that the economy is facing a lot of trouble. It’s just cruising along - it’s (growth) is below its trend line, but if you take into account the world economy, it’s still ok. The mining boom is winding off, so in all circumstances these things should push the growth rate down.

Manufacturing and education sectors must be the stronger export earners from now on. They are going to grow much more strongly now the dollar has fallen 15% in the last three months, which is going to increase production and employment in these sectors.

If we don’t pick up in the education, agriculture and manufacturing sectors we may see another cut, but I think we are going to need to see a strong decline for that to happen. I don’t think they are going to do anything in the next six months. The economy is pretty stable, the currency has depreciated, which is only good news for Australia, house prices are up, and the stock market is flat; everything looks pretty pedestrian. To me this indicates the RBA won’t lower the interest rates, they will want to save up for a rainy day if there should be a collapse in the asset market like we saw in 2008, although I don’t think we’ll see that. The RBA have plenty of scope to lower interest rates in an emergency, so I think they’ll just keep it on hold.

Jeffrey Sheen, Professor and Head of Department of Economics, Macquarie University

Prior to the decision, I did not think a rate change was necessary.

There’s no new information to change my mind on that and so I think it was an unnecessary rate cut. The main justification given is that they previously noted the inflation outlook provided some scope to ease policy further. But inflation is in the middle of their target range, and so I don’t think they have scope to do much. If it goes above three they are outside of their range.

I don’t think inflation is likely to fall. I think the deprecating Australian dollar will push up import prices, which will push up inflation.

I don’t see that this cut will stimulate demand. I think the biggest problems now for the Australian economy are fiscal policy and microeconomic reform issues.

Over the last few months I have said the RBA should not cut the cash rate, but they keep cutting. I am convinced cuts in interest rates are not having much of an impact on demand. I don’t think monetary policy ought to be doing what fiscal policy ought to be doing. Canberra needs to be acting more actively on a number of dimensions.

The cash rate is at a record low, and a problem with further cuts is their effect on confidence. Australia has a confidence problem. We are not acknowledging how well we are doing compared to the rest of the world and that we really are not in trouble. The unemployment rate is creeping up, but the latest increase to 5.7% is not because fewer jobs are being provided; its because more people joined the workforce. Employment actually rose.

I think we should wait and see the impact of the weakening exchange rate. The real exchange rate is what matters and it has only depreciated by 2% since March 2013. In general, I don’t think we have received any new information to justify this policy change.

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4 Comments sorted by

  1. David Stein

    Businessman

    A few points:

    First - the rate cut was imperative to keep downward pressure on the currency. AUD:USD 0.89 is still too high. For this reason alone, the RBA should be applauded.

    Second - this idea that this exchange rate cut will not stimulate demand is simply incorrect. Most homeowners with mortgages have variable rates, and this cut will increase disposable income. Sure, some may choose to pay down debt or save the extra cash, but this only improves confidence particularly when gross employment…

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    1. Garry Baker

      researcher

      In reply to David Stein

      One might agree with all of that David, especially the thoughts on a spending stimulus. However, one might add, there could be some anticipation of a LNP victory in a few weeks time, whereby the Federal belt tightening really gets underway, and discretionary spending by the public then comes to a halt.

      Glenn Stevens has a long record of reading the Tarot cards well, and notably, the Westpac also reacted immediately (wanting to lock in some long term business before the elections) Indeed, my bet is they will be pushing fixed interest, long term loans - Not variables

      The thing is, if the LNP gain power, its a given that General Motors will be gone - at least according to the actions of their boss, Mike Devereux. Ergo, the bad public vibes will spread, so the sun might be setting on Oz.

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  2. Will Hunt

    Farmer

    Now try and get some of it out of your bank

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  3. James Hill

    Industrial Designer

    House prices are up only, perhaps to the extent that a falling dollar has allowed the mainly over-seas buyers to pay more on the exchange rates.
    So let's sell up get rid of the mortgage and the rent, sleep in the car or in a swag on the riverbank and wait for the new manufacturing jobs to pour in.
    It'll be like the Post War Marshall and Macarthur Plans, people living rough but employed, with no giant mortgage overheads.
    Is this the mysterious Abbott plan?
    Abandon suburbia to cashed up foreigners, keeping the banks happy, and set up thousands of tent cities for the Millions strong, "Direct Action!" Green Army, planting trees for a living.
    Very cunning Tony!

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