The Reserve Bank of Australia (RBA) Board met today (1 October 2019) and decided to reduce the cash rate by 25 basis points from 1.00 per cent to 0.75 percent. The main reasons for this reduction in the cash rate stem from weak economic growth both in Australia and internationally, weak consumption growth, and the need to lift the inflation rate to be consistent with the 2 - 3 per cent inflation target.
The RBA seeks to increase economic growth, consumption growth and keep the inflation rate between 2 - 3 per cent. This can be achieved by reducing the cash rate to incentivise investment and stimulate economic growth. The Governor of the RBA mentioned in his statement today the following:
The Australian economy expanded by 1.4 per cent over the year to the June quarter, which was a weaker-than-expected outcome. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increase in household disposable income continuing to weigh on consumer spending.
How does this rate cut affect Australian financial markets?
The reduction in the cash rate is in line with market expectations. Consequently, there has been a slight increase in equity markets. Beyond this initial reaction, companies should be able to borrow at a lower interest rate, incentivising investment through further availability of cheap credit. Additionally, with a lower cash rate, this might incentivise investors to move out of the bond market and into equity markets.
Investors this week should closely watch equity markets to observe the reaction the markets take to the reduction in the cash rate. Also, the banks reaction to this decision in their pricing decisions including housing loans should be closely monitored. Likely, the banks will not pass on the full 25 basis point cut as doing so adversely impacts on their net interest margin (and hence their profitability).
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 a number of 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.
Will there be more rate cuts in the future?
While it is unknown whether the RBA will cut rates again in the coming months, investors can expect Australia to remain in a low-interest-rate environment for an extended period. The RBA Governor made this comment last week. This is because Australia is experiencing below-average level of economic activity in the domestic economy. According to the National Accounts, Gross National Expenditure contributed -0.2 percentage points to growth in the June quarter 2019. A mix of expansionary fiscal and monetary policy is likely needed to stimulate Australia’s domestic economy. Accordingly, the Governor of the RBA mentioned in his statement today that the RBA Board:
Is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
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