The RBA held its latest monthly meeting today, deciding to keep rates on hold at 3%. The decision was widely expected by the market, with the market pricing in a 94% chance that the RBA would hold fire this month.
The RBA cited decreasing global risks, ‘robustly’ stabilisation in China and under-control inflation as among the reasons behind today’s decision and they are clearly in no rush to lower rates.
While today’s decision was pretty much a fait accompli and the RBA is reasonably happy with rates where they are, the market is still expecting the next move to be to the downside.
The RBA itself has said that it has room to cut rates further ‘if needed’. However the RBA also has faith that the cuts it has already made (cuts totalling 1.75% since late 2011) are more than enough to keep the local economy bubbling along.
But while there were some hopes we could see the RBA Target Cash Rate as low as 2% this year, the chances of a string of further cuts is looking increasingly unlikely.
While the Australian economy is not exactly shooting the lights out, there are at least some signs of strength visible. And that is enough for now to convince the RBA not to announce further cuts. Don’t forget, Australian interest rates are at their lowest since the 1950s and the RBA is going to have to see a stack of bad news before it slashes rates further.
The RBA looks at a raft of economic indicators to help it makes up its mind on appropriate interest rate levels; including such things as inflation rates, unemployment levels, retail spending data, terms of trade (Australia’s exports vs imports) and the Aussie dollar.
Let’s take a look at a few of these to see what they say about the economy and the chance of seeing future rate cuts. Firstly, let’s look at the unemployment rate. The chart below shows the unemployment rate tracked monthly over the last five years.
While unemployment is obviously much higher than where it was at the start of the GFC, the latest reading of 5.4% is still considered quite a positive result (and much better than most industrialised nations). Crucially, the last month saw unemployment tick lower with an impressive 71,500 jobs added during February – well ahead of the market’s expectations of 9,500 jobs.
Next, we will look at Retail Sales. The RBA pays a lot of attention to this as it does a great job of summarising households’ wealth, confidence and spending levels. It is a great indicator of whether consumers need stimulating or not.
The chart is quite choppy, and it can be quite hard to get a read on the direction of the trend. However, like the unemployment data the Retail Sales figures painted a particularly positive – if one-off – reading last month. Retail sales growth of 0.9% was the strongest reading since the middle of last year and came on the heels of months of seeing retail spending actually shrink across the country.
Now both of those charts show some recent positive readings amid generally middling trends. So why doesn’t the RBA just keep cutting rates? What do they have to fear? The answer is inflation. The RBA is worried that if they cut rates too far or too quickly, then inflation (prices of goods and services going up) will run out of control. And keeping inflation under control – ideally between 2% and 3% – is one of the RBA’s key goals.
The chart above shows inflation on a quarterly basis over the last 10 years. You can see that current levels are some of the lowest seen in the last decade and the last reading of 2.2% is well comfortably within the 3% limit that the RBA aims for. The RBA today acknowledged that inflation is consistent with its medium-term targets.
So where to from here?
The recent RBA rhetoric has clearly been painting a picture that the RBA is not going to cut rates further unless things go to hell in a hand basket. Short of a major global financial shock and/or a sudden and sharp deterioration in the local economy we don’t see any more cuts in the coming months.
The RBA thinks its previous cuts are doing the job intended and won’t cut further until they see proof otherwise.
Looking at the bond futures markets, we can see that the financial markets are currently pricing in rates to be at 2.77% by the end of 2013. So according to the market’s current thinking, at best expect to see one more rate cut by December. And the chances of rate cuts (according to the market) are falling every day. Late last year, the market was expecting rates to be down to 2.35% by the end of the year!
So you can see that with rates back to record lows, the days of hoping for a series of more rate cuts (at least by mortgage holders, not retirees/savers) are clearly over. The only thing that will see rates down to near 2% is some kind of economic meltdown. And that’s something that nobody is cheering for.
This editorial was published to our Investors report Tuesday 2nd April – Access the investors report FREE for 7 days