Interest rates and the RBA

Interest rates and the RBA

MRD Fact Sheet

The job of the Reserve Bank of Australia (RBA) is to keep the Consumer Price Index (CPI), or inflation, between 2 percent and 3 percent.

An inflation rate below 2 percent indicates a sluggish economy that needs stimulating, and so by lowering the Official Cash Rate (interest rates), people and businesses have more money to spend in the economy and are more inclined to invest.

An inflation rate of more than 3 percent indicates a heated economy, where spending / investing levels are seen to be unhealthily high; thus the RBA puts interest rates up to slow the economy and bring inflation back down to between 2 and 3 percent.

Interest rates are about to be lowered

It’s a given that interest rates will drop in the first half of 2016, but the $64,000 question is will the RBA cut them when they meet next Tuesday?

Back in November last year, Glenn Stevens, governor of the RBA, told a gathering he addressed that if interest rates were to move in the near term, they would go down rather than up.

Rates to be cut to 1.75 percent

Currently, the cash rate sits at 2 percent; the lowest it has been in most of my reader’s lifetime.

Citigroup’s ‘interest rate futures pricing’ last year gave a 50 percent chance to the RBA cutting interest rates to 1.75 percent by June 2016

Today, Citigroup’s ‘interest rate futures pricing’ give that rate cut a 100 percent chance! That is, they say it is going to happen by June this year.

When will interest rates be cut

While it is widely accepted that they will be going down again soon, the odds of a rate cut next Tuesday are considered low.

I love to offer my opinion / commentary on this subject and even go out on a limb and say what I think will happen and why.

I am going to predict that rates will come down when the RBA board meets next Tuesday.

Of course nobody knows for sure but here are my reasons for not sitting on the fence and not simply agreeing with popular opinion.

  • In February last year the RBA cut rates and surprised the markets. Economists were not expecting them to do that at their first meeting for 2015
  • The World Bank has forecast that oil prices will remain low throughout 2016.
  • The December 2015 CPI figures were released on January 27th and the Weighted average of Australia’s eight capital cities, across all groups (food, entertainment, housing etc.) came in at 0.4 percent.
  • Inflation for the year to the December quarter was 1.7 percent, up from 1.5 percent for the year to the September quarter.
  • While this shows a slight jump it is still well below the 2 percent to 3 percent range that the RBA is charged to have inflation sit at.

I could be very wrong and come Tuesday we may get the news that “the Reserve Bank has left interest rates on hold for another month”.

But I go back to what I said earlier:

“The job of the Reserve Bank of Australia (RBA) is to keep the Consumer Price Index (CPI), or inflation, between 2 percent and 3 percent.”

Our inflation rate is well below 2 percent, commodity prices are low, manufacturing has suffered in recent times and unemployment levels are higher than they should be.

Our economy would only benefit from the stimulus an interest rate cut would produce as so regardless of what the RBA does or doesn’t do when they meet on Tuesday, they should cut rates sooner and not put the inevitable till later in the year.

The only reason that I can see for not lowering rates is a fear that they will over stimulate the Sydney and Melbourne property markets.

Following the release of the Australian Prudential Regulation Authority’s (APRA) report into the finance industry, the big four banks made changes to their lending policies. These changes have already resulted in slowing of lending for investment purposes.

No more excuses

So from my vantage point, the RBA has no valid reason for not lowering the cash rate on Tuesday; but we will have to wait to see if their thinking aligns with mine or not.

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Nick Lockhart