Australia’s new record low interest rate of 1.5% has been introduced because of global economic conditions, more than any other factor. As a new wave and various forms of global monetary policy easing commences, the Reserve Bank of Australia is responding in suit, cutting the official cash rate for the thirteenth consecutive time.
The rate cut, determined by the RBA Board on 2nd August, placed Australia’s trading position ahead of concerns about over-stimulation of the housing market. This signal appears to have been received by the largest banks, which reduced home loan interest rates, but only passed on half of the 0.25% interest rate decrease. Instead, the big four banks increased deposit interest rates.
The chart below, produced from RBA data, shows Australia’s official interest rate, over the period since January 2011.
It is difficult to escape the conclusion that, albeit reluctantly, the RBA has been drawn into the global round of monetary policy adjustments, presumably in the expectation that the pressures on the Australian Dollar will diminish, at least for a time.
It was lost on no one that the interest rate cut was followed by a quick dip down, before the currency rebounded to end the day marginally higher than at the point when the announcement was made.
It has become a global truism that each successive interest rate cut or significant monetary policy movement sees capital market responses be less pronounced and shorter-lived, but a couple of hours is not much reward for the export economy relying on a more responsive exchange rate.
That is significant, but it may not ultimately be the main issue confronting the RBA right now.
As Jennifer Hewett wrote in the Australian Financial Review on 3rd August:
“What it can’t do is provide any real confidence this will suddenly stimulate that elusive improvement in business investment that underpins any sustained economic growth.”
And that’s the problem with playing to the global position and the state of the nation’s currency. It runs the risk of ignoring the domestic reality that, again as Hewett puts it:
“It’s not as if there’s any lack of cheap finance for the past few years. Its more the lack of willingness to use it.”
The cost of capital is low, extremely low by any measure. As the RBA Governor Glenn Stevens commented in his statement on monetary policy, immediately following the rate cut:
“Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative.”
It is possible to hear the RBA Governor in a different voice saying, ‘Invest. Do it now. It cannot get better than this.’ He is of course correct, but it all seems to little avail.
Businesses are reluctant to invest, apparently uncertain that the returns on their new investments will cover the costs of the capital, interest and implied risk (the discount rate). The latest interest rate cut will not help on that front.
This lack of business investment flows through to lower inflation in Australia, which the RBA considers will improve, driven by ‘sustainable growth in the economy’. The RBA is banking on the interest rate cut contributing to that growth and inflation.
However, as Callam Pickering, CP Economics wrote online, on 2nd August, sustainable growth:
“…has been undermined by Australia’s ‘income recession’ with growth increasingly driven by a combination of net exports, housing construction and the wealth effect driven by Sydney and Melbourne property.”
So what are the likely effects of a further interest rate cut then? It is said that only the truly insane expect a different result from the same behaviour, so we have to assume that this interest rate cut will see property prices (investor driven) rise, especially in Sydney and Melbourne, a little more new house lending and perhaps a few days more of slightly more competitive exports.
If that is so, then it’s difficult to escape the thought that this was not an interest rate cut the RBA was keen to introduce. However, the income shock Callam Pickering described in the quote above, has been massive, by any measure. Again, as Pickering wrote:
“The problem is one of magnitude. The income shock Australia has experienced is considerable and 300 basis points hasn’t been enough to turn the ship around even though it has helped a lot. For those who question whether interest rates can support activity ask yourself this: where would the Australian economy be without those 300 basis points? My guess is in recession.”
That is salutary advice. After all, an economy like Australia’s is a very big ship in a massive sea. It takes time to turn the ship and the exact direction and new headings are uncertain.
The RBA is banking on hope and more than a little patience, when it comes to the domestic economy. While hope springs eternal, the truth is that the RBA does not have a crystal ball and cannot be certain what the response will be. What is certain is that as each interest rate cut has occurred, the RBA has been left with less shots in the locker.
The RBA is stuck between a global rock and a domestic hard place, but as the stone-faced central banker would insist, it aint time to panic just yet.
Surveys of bank economists and analysis of bond rates indicate financial markets have factored in a roughly even chance of a further 0.25% rate cut by November.