RBA Cash Rate Historic Graph

I’m Not Sure Another Rate Cut Is Warranted.

If you’re a home owner with a variable rate mortgage the past year has been pretty kind to you with the RBA slashing a good 1% off the cash rate, an extraordinary amount of breathing room for many people. It’s also provided some relief for those who dived head first into the property market at the bottom of the Global Financial Crisis, taking advantage of the cheap rates, and over-extended themselves with a loan that was too big for them to handle comfortably. This in turn should be putting an upwards pressure on inflation as people spend more thanks to their incomes being freed up from mortgage payments however it seems that the past year of cuts wasn’t enough and the Reserve Bank of Australia might be lining up to cut rates yet again.

Futures markets have been pricing in a rate cut with a likelihood of 85% which means they’re almost certain that the RBA will cut rates in November. There are several plausible reasons for this like the government returning the budget to surplus and inflation coming in below the RBA’s target however some of the other reasons cited have me a little confused. Weaker currency prices aren’t fixed by rate cuts, they will actually make the currency comparatively cheaper, and citing them as a reason to cut rates would be counter-intuitive. I might be misinterpreting what the article means however as the currency trading rates are only casually mentioned.

The reason why this rate cut and not the ones preceding it have got my attention is the fact that with 1 more 25 basis point cut to the official cash rate we will officially be equal to the rates we saw back when the GFC was in full effect. Now we’re not exactly in the best of times at the moment with the Eurozone Crisis still playing out however we’re not in the midst of a global recession either with most developed countries, including the instigator of the last crisis, having several quarters of positive growth under their belt. The unemployment rate, whilst still being far above its pre-GFC minimum, has remained fairly steady in the 5% range over the past year as well which makes it even more confusing as to why the RBA would look to cut rates at this time.

Looking at their decision for this month where they cut 25 basis points off the rate it’s clear that they’re taking a pretty long term view and I’m not sure what’s changed in the weeks since then that could lead them to believe that they needed to drop rates to a record equalling low. The softer global economic outlook, lower commodity prices and low inflation are all valid reasons to drop the rate however they really haven’t changed in the past month and if another drop is warranted so soon after the previous one it could have easily been rolled into it, giving a single cut of 50 basis points. The RBA is usually reluctant to do rate cuts of that magnitude however (last time it happened was at the start of this year and prior to that it was the massive cuts due to the GFC) but the flip side of that is that the markets usually react better to larger cuts. I’m no economist though so there might be some deeper strategy to this that I’m just not seeing.

Considering the relative economic positions between the peak of the GFC and now it just seems odd that we need to have the cash rate at the same level. The global economy not hurting anywhere near as bad as it was at the same time all those years ago and whilst there are indicators that suggest a rate cut might be warranted it seems over zealous to drive them down to the same levels as when we were on the verge of recession. I’m most certainly not going to complain however as it only means good things for my current investments but I’m more interested in the underlying factors that might drive such a cut. I guess we’ll have to wait until November 6 to find out as anything up until then is going to be firmly in the realms of speculation.

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  1. If you’re wondering about unemployment rate being steady I recommend you check out the difference between ABS rate and Roy Morgan rate. Historically the difference between the two rates is 2% however it is now 5%. Give or take a few 0.2%. Why? ABS rate doesn’t really factor in underemployment. Whilst the Morgan rate does. As such the diveraging measures is a sign the economy isn’t very strong at all. Hence the falling interest rates.

    Also in my industry (Architecture) I’m hearing some bad stories of lay-offs out there. One firm has shed 75% of it’s workforce from 30-40 to 8. This last happened pre-GFC. The canaries in the coalface are falling again. If we aren’t designing buildings, the building industry won’t be building them in the near future either.

  2. Sure there’s a difference in the numbers however there’s still been little movement in either over the past year (http://www.roymorgan.com/news/polls/2012/4829/ for reference). It might place unemployment at a much higher rate but there’s been no trend upwards in unemployment by either measure which is usually a key factor in the RBA looking to drop the cash rate. Indeed they seem to mirror each other quite closely in terms of trends, just that the Morgan rate is higher.

    I happen to know people in the architecture industry as well and they haven’t seen any layoffs recently, but we know the plural of anecdotes isn’t data ;)

    The construction industry has been down for the past year or so and that could easily explain the flow on effects going back to the supporting industries, like architecture. It’s also true that other industries are still experiencing booms (resources being chief among them) so what holds true for one industry can’t be used as a rule for the rest.

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