Interest rate moves are a bit like ‘cockroaches’

01_Interest rate moves are a bit like _cockroaches_

By Dr Shane Oliver

AMP Capital

Chief Economist and Head of the Investment Strategy team

In the most anticipated interest rate decision in a year the Reserve Bank of Australia (RBA) cut the official cash rate by 0.25% taking it to 1.75%, its lowest on record.

Money markets had priced in just over a 50% probability of a cut and economists were split roughly 60%/40% in favour of no change.

In justifying the move, the RBA cited unexpectedly low inflation data recently and a lower outlook for inflation that had been previously forecast. While the RBA seems reasonably content with the rebalancing of the economy, it’s clearly concerned that if it doesn’t act quickly then low sub-target inflation as we have seen recently will start to feed through to inflation expectations and become self-perpetuating just as Japan has seen over the last two decades.

Source: ABS, AMP Capital

Justifying the rate cut

The RBA also referred to an appreciation in the Australian dollar complicating the economic adjustment in the economy, so the Australian dollar’s strength was clearly a secondary factor justifying the cut. Just prior to the decision the Australian dollar had pushed back above $US0.77 and looked likely to push on to $US0.78 if the RBA didn’t move. In the event the RBA’s cut has pushed it back down below $US0.76.

Will there be another cut and what does it mean for lending?

Interest rate moves are a bit like cockroaches – if you see one there is usually another one lurking nearby. So given the downside risks to inflation, the upside risks to growth from a loss of momentum in housing construction and the upside risks to the Australian dollar if the US Federal Reserve continues to delay rate hikes our view is that there is likely to be another rate cut taking the cash rate to 1.5%. Given the RBA’s preference for moves in mid quarter months when it reviews its economic forecasts this is most likely to come in August.

Surprisingly one bank at least has already passed on the 0.25% cut in full to home loan customers. Others may hold a back given ‘rising funding costs’ but the savings on debt interest costs will help boost household spending. Don’t forget that the value of household debt is more than double that of household bank deposits so the savings for those with a mortgage swamp the loss of income for those relying on bank interest.

Quite clearly, there is a risk that the latest RBA rate cut reinvigorates the home price boom in Sydney and Melbourne. The RBA has clearly thought about that risk and concluded that the risks are lower than was the case a year ago, that it has to set interest rates for the average of the economy not just one sector (or two cities) and that in any case if trouble re-emerges it can always work with the Australian Prudential Regulation Authority to tighten the macro prudential screws on bank lending to home buyers.

Final thoughts

For investors relying on bank interest, the decision by the RBA to cut the cash rate again will push deposit rates further down to levels not seen since the 1950s. Beyond day to day cash requirements, the key for investors currently in cash or term deposits is to work out what is most important to them: absolute certainty regarding the capital value of their investment or obtaining access to a higher more stable income flow at the cost of volatility in the value of their investment. In this, there are several alternative investments to cash.

 

About the Author

Dr Shane Oliver, Head of Investment Strategy and Chief EconomistDr Shane Oliver is Chief Economist and Head of the Investment Strategy and Economics team at AMP Capital. The team is responsible for the provision of economic and macro investment analysis, and determines the asset allocation policy which is applied across AMP Capital’s multi-asset funds.

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