The Reserve Bank of Australia (RBA) Board met today (3 March 2020) and decided to reduce the cash rate by 25 basis points from 0.75% to 0.50%.
What are the main causes of this rate cut?
The main reason for this rate cut is in response to the global coronavirus outbreak. The coronavirus outbreak is expected to slow global economic growth over at least the short term. The coronavirus outbreak is having a significant effect on the Australian economy, and the effects are most prevalent in education and travel sectors. The RBA has mentioned that domestic spending is likely to be considerably weaker in the March quarter, and possibly the quarters following.
Another important point to note is that the coronavirus has shocked financial markets across the globe. In Australia, the ASX 200 was down around 11% over the last week. In the United States, the Dow Jones Industrial Average and the S&P 500 were down around 10% over the last week. However, in both Australian and US markets today (3 March 2020), the market are up strongly.
Australia’s unemployment has remained steady at 5.3%, while inflation remains below the 2 -3% inflation range. Wage growth has remained subdued and is not expected to pick up for some time. The RBA notes that for inflation to be stable in the range of 2 – 3%, wage growth is needed to occur over the next 12 months.
Overall, the RBA’s decision to cut the cash rate is to ensure the stability in Australian financial markets and to allow the financial system to have sufficient liquidly and to respond to weakening economic growth due to the coronavirus outbreak.
Will the rate cut stimulate economic growth?
The reduction in the cash rate today while positive, it is unlikely to stimulate the economy by itself. Australia has been in a low-interest rate environment for several years, yet GDP growth has been consistently under trend growth (which is around 3.1 per cent annual GDP growth) and the inflation remains below the 2-3 target. The Government’s reductions to income tax could provide a stimulus to the economy but there is little evidence of this. The depreciation of the $A exchange, which is now at its lowest level for a decade or so, provides a stimulatory boost to the economy.
Will there be more rate cuts in the future?
Investors can expect Australia to remain in a low-interest rate environment for an extended period. This is because Australia is experiencing below average level of economic activity in the domestic economy. In addition, it is unclear if the global coronavirus outbreak will be contained, thus the effect on economic activity is likely to be negative over the short to medium-term.
What is the market reaction?
The ASX has slightly recovered today from the previous landside last week. The RBA has met market expectations of a rate cut and the market is up around 1.4% at the time of writing.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
(“ASR”). ASR is part of Amalgamated Australian Investment Group Limited (AAIG) (ABN: 81 140 208 288 Level 13, 130 Pitt Street, Sydney NSW 2000).
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