The RBA decided to lower the cash rate by 0.25% to 2.25%. The rate and the RBA’s policy stance had been on hold since the last rate cut in August 2013.

The decision was largely unexpected by markets, though recent murmurings had the probability of a rate cut at 60%. It appears the RBA may have moved too early given recent data is seasonal and limited. However, monetary policy settings have eased recently in Europe and Canada, and the RBA may have been concerned with moving too late to cut rates given there is a reasonable lag effect following a change to the cash rate.

In their statement, the RBA cited weakening of the Euro area and Japanese economies, along with the sharp fall in commodity prices, reflecting a combination of lower growth in demand and increases in supply.

The main concern for the RBA was the Australian economy growing below trend with weak domestic demand growth and the large fall in the terms of trade (difference between what we get paid for exports versus what we pay for imports) severely reducing income growth for the economy. As a result, they expect the unemployment rate to rise a fair bit from current levels and inflation to remain low as labour costs remain subdued.

They also cited the pick-up in credit growth, which has largely been seen in the strong growth in lending to investors in residential housing. However, they did note that continued strong house price rises in Sydney were somewhat at odds to the trends in a number of other cities more recently. The RBA specifically made mention of the work they’re doing with regulators to curb risks arising from excessive house price growth. Though, the rate cut at today’s meeting will make it increasingly difficult for them to curb these risks.

The RBA maintains that the dollar needs to be lower against all currencies, not just the US. They appear to have become concerned with the Australian dollar stabilising in the high 70s (against the US dollar) and it actually rising against other currencies, given the expected delay in the US central bank raising rates (second half of this year now looking likely) and the recent announcement of quantitative easing in the Eurozone (significant downward pressure on the Euro).

On balance, the rate cut appears to be a pre-emptive move to counter the expected weaker economic conditions ahead in the first half of this year. Time will tell if they were correct, but we think they have moved too quickly. The market may now begin to expect another rate cut in quick succession, but we think the RBA will hold for at least the next few months to assess the effects of today’s cut.

At time of writing, the Australian dollar is down 1.77% to 0.76 against the US dollar; the equity market is up 1.60% having moved sharply higher post the RBA’s announcement.

Article written by PSK Financial Services


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