Between November 2011 and yesterday, the RBA has cut interest rates by 1.75 percentage points. Yesterday, evidently frustrated at the failure of the economy to respond to what should have been a substantial stimulus and at the dollar for failing to respond at all, it cut again, in a move that surprised many economists (and us).
The change in approach by the RBA can be seen in the altered language about the impact of the preceding rate cuts. In speeches and statements, the RBA has seemed increasingly confident that lower interest rates were “gaining traction” and boosting demand in non-resource sectors of the economy, such as residential construction. At its April meeting the bank said recent data suggested sensitive parts of the economy were responding to the historically low cash rate. But not fast enough at the May meeting, for the bank to remain confident that would still be the case later in the year, so it seems.
This comment from governor Glenn Stevens admits as much:
“The Board has previously noted that the inflation outlook would afford scope to ease further, should that be necessary to support demand. At today’s meeting the Board decided to use some of that scope. It judged that a further decline in the cash rate was appropriate to encourage sustainable growth in the economy, consistent with achieving the inflation target.”
There are some faint similarities with RBA decision and those from the European Central Bank, the Bank of Japan and the US Fed this year, all of which seem to have become frustrated with the reluctance of their economies (which are basket cases, compared with ours) to respond to major policy changes.
The RBA is using the traditional blunt instrument of monetary policy (rate cuts) to try to get demand levels in the domestic economy growing faster ahead of the slowdown in resource investment later this year. The US Fed, the Bank of England, the ECB and the Bank of Japan, with rates already more or less at zero, have resorted to more unconventional policy tools such as quantitative easing, while the ECB has backstopped the eurozone’s floundering banks and supported weaker economies by buying debt. But the record low rates in Europe, UK, Japan and the US, and the huge multitrillion-dollar spending sprees haven’t really cut unemployment or sparked a surge in demand in any of these huge economies. Conditions have improved, but economies remain sluggish to, in the case of Europe, depressed.
But one common factor in every case other than Japan has been fiscal consolidation by governments. Ignore the headlines about revenue writedowns for a moment — federal government spending this year is still expected to contract by 1.5% of GDP. Most state and territory governments are also cutting spending. That’s a significant countervailing force to the RBA’s efforts to lift domestic non-mining growth.
The other countervailing force, obviously, is the dollar. There’s a line being run by a number of armchair generals in the media who want to see a currency war that yesterday’s cut was squarely aimed at reducing the dollar. Stevens singled out the currency for special mention:
“The exchange rate, on the other hand, has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates during that time. Moreover, the demand for credit remains, at this point, relatively subdued.”
But focusing solely on the dollar overlooks that the RBA is trying to support the economy while the government is ripping demand out of it. So the rate cut was aimed at achieving several things — providing some extra stimulus for the economy ahead of what’s expected to be a tough budget, bolster faltering growth in housing and non-resource investment, and putting downward pressure on the dollar.
Whether this cut will be any more successful than the previous 1.75 percentage points of cuts is a good question. It will mean lower rates on term deposits as they roll over and lower rates for transaction accounts. And more than half of mortgage holders have been using the rate cut to repay their loans faster than they have to. Home lending is weak, but the 4.4% growth in lending in the year to March was far stronger than the 1.6% growth in business lending in the same time. No wonder overall credit growth is subdued at 3.2% in the year to March.
The cut knocked the dollar lower after it weakened by more than a third of a cent ahead of the decision at 2.30pm. After that it lost half a cent against the greenback, to be nearly four cents lower than its high last month. But it then recovered slowly, before easing to finish this morning in New York at 1.0180. Despite what the armchair generals at The AFR are saying, it will take more than a 0.25 percentage point rate cut to inflict serious damage on the dollar. That AAA stable credit rating the same generals have demanded for years is a powerful attraction to investors chasing yield.
The rate cut will result in investor interest turning further toward the sharemarket and high-yield shares such as the banks (listen for another chorus of “bank bubble booms’ from the generals and their officers), Telstra and some industrial shares. Dividend yields of 4% or more will look better than bank deposits of 4% or less as the rate cut works its way through bank term deposits and account rates.
The move came despite the overwhelming forecasts by economists surveyed by Reuters and The Wall Street Journal that the bank wouldn’t cut rates. The consensus was for a rate cut in June, after the federal budget. Reuters’ survey had just four of 21 respondents predicting a cut, while one from The Journal had only two of 18 economists expecting a cut. But market traders had priced in a 61% chance of a cut yesterday morning and that had tightened a lot in the past week. Screen jockeys: 1, economists: o. But amid all the hysterics about a “budget out of control”, perhaps we need to wonder why the RBA is having to push rates down to such lows in an effort to spark the domestic economy.