The Reserve Bank will cut rates again in coming months, with some economists predicting the cash rate could be under 2% by year’s end – and there’s a very simple reason for this, the economy is slowly, but surely sliding towards a halt.
The news helped boost the ASX 200 by 1.4% or more than 80 points and saw the Aussie dollar fall more than 2c to well under 77 USc. Australian government bonds fell to new lows with the 10 year bond reaching 2.25% in late trading, an all time low.
The 0.25% rate cut, to a new record of 2.25% yesterday was widely tipped by the traders in bond futures, but not by business economists working for banks and others in the markets. They overwhelmingly thought the bank would sit and cut next month or in April.
Talk from the Federal government yesterday, led by Treasurer Joe Hockey, the real estate sector, plus other areas of business, not to mention folk in the markets, that the rate cut will boost confidence and activity, ignores the central bank’s reason – the slowing level of activity and demand in the economy – for the rate cut.
In his statement, RBA Governor Glenn Stevens said:
"In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year.
"The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet,” Mr Stevens said.
That is as clear a warning to everyone in the country, from the markets, to unions, to governments and business, that the bank sees the economy slowing further in coming months – the possibility of a quarter or two of negative growth can’t be ruled out on the basis of these comments.
What many people fail to realise is that at 2.50% (from August 2013), the cash rate was at a record low, and after the boom in iron ore prices in calendar 2014 faded by mid-year, and other commodity prices started falling (and the value of the dollar refused to fall as far and as fast as the RBA thought it would), the economy slowed through the year.
It appears the RBA thinks it has slowed further and will go on slowing in coming months. We will get its longer term estimates when it releases its first Statement of Monetary Policy for the year on Friday with its updated outlook for growth and inflation.
The bank now sees the jobs market worsening, which would indicate it thinks the upturn in the final quarter of 2014 was a one-off. The peak for the unemployment rate wasn’t given, but could be above 6.5% and closer to 6.75%.
The final paragraph of the statement, where the bank’s interest rate policy is explained (It talked about a “prudent course” for much of last year to do nothing and sit on 2.50%), contained the biggest change in yesterday’s statement (see the accompanying story).
"For the past year and a half, the cash rate has been stable, as the Board has taken time to assess the effects of the substantial easing in policy that had already been put in place and monitored developments in Australia and abroad. At today’s meeting, taking into account the flow of recent information and updated forecasts, the Board judged that, on balance, a further reduction in the cash rate was appropriate. This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target.” (My emphasis).
No more talk of a “prudent course’ which means that the central bank and its economists are worried the economy could slow to stalling point and needs a sugar hit from one or more cuts to its key interest rate.
The RBA has joined central banks in South Korea, China, India and Canada which have all cut rates in the past month or so on the back of plunging oil prices and sluggish economic growth.
Denmark and Switzerland have cut their rates to negative levels for different reasons – to try and stop investors placing their money in those economies as the problems in Greece roil euromarkets and confidence.
