What the RBA’s 0.25% Interest Rate Cut Means for the Economy

The RBA’s decision to cut interest rates by 0.25% is the best the economy could hope for. At the official cash rate of 2%, it was the half way compromise that markets will accept — for now.

I was worried for a moment that Editor Kris Sayce over at Money Morning would be proven right. He said the RBA could cut rates by 50 basis points.

They didn’t, but his reasoning wasn’t wrong. As Kris says, we’re heading for more interest rate cuts one way or another. The RBA will cut rates again in the coming months, it’s just a question of when. That’s because the RBA will need to further devalue the dollar to boost the economy. A lower dollar is important to jolt businesses into investing and hiring. And it makes our exports more competitive.

We haven’t reached the negative interest rates of the Eurozone yet, but the RBA are leading us there — they’re just doing it in a measured, drawn out way.

Why renewed consumer confidence kept the cut at 0.25%

The RBA are always talking about confidence. You’d sure feel a lot more confident about your investments if the cash rate was cut by 0.50% to 1.75%. Lower rates make credit cheaper. That’s why Kris predicted the RBA would stun the markets into action today. But that would’ve been one step too far. You could already see that from business data in the past month.

Unemployment dropped slightly to 6.1% in March. Iron ore prices have rebounded back above $58 per tonne. The resurgence has come on the back of suppliers cutting production outputs to ease pressure on the market.

The RBA also pointed towards improved consumer spending and demand over the past six months as a sign of economic stability.

Those factors pointed to a marginal cut at best. And that’s exactly what we got. The RBA also indicated that inflation is expected to remain consistent with the target over the next few years (between 2-3%).

Why the RBA will continue to drive down the value of the dollar

Markets and Money Editor Greg Canavan explains this better than I ever could. He says that the stronger Aussie dollar was the major reason the RBA would act to cut rates today.

The dollar had crept back above $o.80 against the US dollar this week. That’s not what the RBA wants to see because it hurts our ailing exporters. The last thing the mining giants want to see is an Australian dollar at parity with the greenback. So RBA chief Glenn Stevens’ statement that further dollar devaluation was imminent will go down well with investors.

But the housing market still concerns the RBA. Auction clearance rates in Sydney were the third highest ever recorded over the weekend. And as Greg says, rising property prices with non-existent wage growth isn’t sustainable in the long run. The further the RBA devalues the dollar, the closer we get to a financial meltdown. You can’t keep inflating your problems away. It’s no surprise then that Greg’s been saying we’ll be lucky to avoid a recession this year.

Markets respond well to decision

The markets responded well ahead of the decision this morning. ANZ [ASX:ANZ] posted profits of $3.68 billion for the year. And with the imminent rate cut, investors were quick to reward ANZ. Shares are trading up by $1.04 since yesterday (as of 5 May 12:00PM).

The big banks all saw share prices rise by more than 1% since trading opened. Only Westpac [ASX:WBC] saw a rise of less than that (0.8%). That was mostly due to yesterday’s subdued first half profits. Investors will be concerned because Morgan Stanley [NYSE:MS] analysts say that Westpac’s dividends will be flat for the next three half-years.

Other major companies saw similar jumps in share prices. Telstra [ASX:TLS] is up 1%. BHP Billiton [ASX:BHP] saw an increase of 0.7%. Rio Tinto [ASX:RIO] wasn’t far behind with a 0.6% rise.

But as Kris says, none of this gets the markets too excited. The initial rally from the market died down in the lead up to the decision. ANZ dropped by $0.10 following the RBA’s decision.

So now the wait for the next rate cut begins. Whether the RBA’s cuts this year will be enough to stimulate the economy away from a recession remains to be seen.

Greg doesn’t think so. He’s written a free report for investors: ‘Australian Recession 2015: Why It’s Unavoidable and the Quickest Way to Protect Your Wealth’. Greg reveals the six charts from within the RBA that prove we’re headed for a recession. In the report he also shows you his four step investment plan to protect your wealth from the fallout. To find out how to download a copy of the report, click here.

Mat Spasic,

Contributor, Markets and Money

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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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