Making sense of the latest interest rate cut

By Michael Beresford, Director, Investment Services

Just a quick update and commentary on this week’s announcement from the Reserve Bank of Australia (RBA) that it will cut the official cash rate by 0.25 per cent to a new record low of 0.75 per cent.

In one of my earlier videos, I mentioned that we were expecting interest rates to drop another once or twice between now and Christmas. That obviously happened this week. It wasn’t rocket science. It was tipped by about 80 per cent of the prominent economists in the lead up to that announcement.

What’s far more relevant though is what does it mean for us and what’s the impact on the economy? Why are they doing this?

Firstly, the main motivation of the RBA is to really strengthen the economy. Inflation is low, wage growth is low, and specifically in the commentary from the minutes of this week’s meeting, they talked about doing whatever was required, was pretty much the message, to bring Australia to a full employment.

Now, that generally means somewhere between 4.5 to 5 per cent as an unemployment rate. So we are slightly above that. As a nation, if we look specifically at Sydney though, the Sydney unemployment rate is ticking around 4 per cent but even with that low unemployment rate, we haven’t yet seen that translate into significant wage growth.

Strengthen the economy

So that’s why the commentary from the RBA is that they’ve cut, and they will continue to cut in order to strengthen the economy and get that cash flow happening.

In my opinion, what we really need at this point is for the government to step up, because consumer spending is low, inflation is low and so forth.

The government seems, because of its election promise, hell bent on getting to a surplus. What that actually does is it takes money out of the economy.

Effectively if the government is saving and stashing the money away, then that’s what businesses are doing. That’s what we’re doing as consumers. We’re not spending and that’s not promoting the economic growth and the inflation that we need to get it back into the target range.

Hopefully that puts some context on what’s happening and why they’re doing it.

Trend towards zero

In terms of the big banks, the government has always deferred to putting the pressure on the banks to pass it on in full. That’s less of what we need. As interest rates drop and the cash rate continues to trend towards zero, it becomes harder and harder for banks to remain profitable and pass that interest rate cut on in full.

At time of writing, the CBA had come out and said they would drop owner-occupied interest rates by 13 basis points. What was interesting was that their investor interest-only loans would actually have the rate cut passed on in full by 25 basis points.

So what we’ve seen over the last couple of years is that that gap between the owner-occupied rates and the investment rates was widening. At least CBA’s decision late yesterday was that gap is going to retract a little bit and bring those rates back towards parity.

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