The RBA has been on a cutting cycle since November 2011, right around the time the Sydney and Melbourne housing markets started their respective meteoric booms. The cash rate peaked at 4.75 per cent in October 2011 before being reduced; slowly at first then quite dramatically.
By the end of the following year it was down to 3 per cent and falling. The last 25 basis point reduction was made on Tuesday, 2 August 2016.
To understand what prompted the RBA to make its last rate reduction almost three years ago, one needs to simply read the statement by then-governor Glenn Stevens:
“Recent data confirms that inflation remains quite low. Given very subdued growth in labour costs and very low-cost pressures elsewhere in the world, this is expected to remain the case for some time,” he said.
“The board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting.
Now, in 2019, it seems as if we have a case of history is repeating. Less than a week ago the ABS released the Consumer Price Index, which measures underlying inflation.
“Australia’s inflationary pressures continued to ease in the March quarter, setting the scene for a rate cut later in the year,” Morningstar Australasia head of equities research Peter Warnes said.
“The headline consumer price index was unchanged from the December quarter and the y/y change down from 1.8 per cent y/y at December to 1.3 per cent. Markets were expecting a quarterly increase of 0.2 per cent and a y/y rate of 1.5 per cent.”
Core or underlying inflation, a measure the RBA takes more notice of when setting monetary policy, rose by 0.2 of a percentage point, well below expectations of 0.4 of a percentage point.
“It was the weakest quarterly increase on record, pushing the March 2016 reading out of the record books. It was after the March 2016 slide, the RBA cut rates twice,” Mr Warnes said.
AMP Capital chief economist Shane Oliver is confident the Reserve Bank could cut rates as early as next week, betting on a 1 per cent cash rate by year end.
The Aussie equity market surged on the weak inflation data, comforted by the expectation of lower rates.
Low inflation is generally good for shares, according to Mr Oliver, as it allows shares to trade on higher price to earnings multiples.
“But deflation tends to be bad for shares as it tends to go with poor growth and profits and as a result shares trade on lower PEs. The same would apply to assets like commercial property and infrastructure,” he noted.
Those with a mortgage will be the obvious beneficiaries, depending on whether or not the banks pass on the rate cut in full.
Some worry that rate cuts won’t help as they cut the spending power of retirees and many of those with a mortgage just maintain their payments when rates fall. However, there are several points to note regarding this. First, the level of household deposits in Australia at $1.1 trillion is swamped by the level of household debt at $2.4 trillion. So the household sector is a net beneficiary of lower interest rates,” Mr Oliver said.
“Second, the responsiveness to changes in spending power for a family with a mortgage is far greater than for retirees.
Third, even if many with a mortgage just let their debt get paid off faster in response to falling rates this still provides an offset to the negative wealth effect of falling house prices, reducing pressure to cut spending.
“Fourth, the fall in rates since 2011 has helped the economy keep growing as mining investment collapsed. And of course, RBA rate cuts help push the Aussie dollar lower. So, while rate cuts may not be as potent with higher household debt levels today and tighter bank lending standards, they should provide some help.”
In terms of broader investment trends, a rate cut will certainly prolong the chase for yield as the low interest rate environment shows no signs of turning around anytime soon.
Mr Oliver sees this supporting the demand for alternative assets like commercial property, infrastructure and equities that offer sustainable high yield dividends.
Bank deposit rates will remain unattractive for some time, but the chief economist doesn’t anticipate a 1994-style bond crash given the lack of inflationary pressure.
“Due to the slowdown in economic growth flowing partly from the housing downturn we have been looking for two rate cuts this year since last December. We had thought that the RBA would prefer to wait till after the election is out of the way before starting to move and coming fiscal stimulus from July also supports the case to wait as does the still strong labour market,” Mr Oliver said.
However, with underlying inflation coming in much weaker than expected the RBA its arguably too risky to wait until unemployment starts to trend up. And the RBA has moved in both the 2007 and 2013 election campaigns.
“So, while it’s a lose call, our base case is now for the first rate cut to occur at the RBA’s May meeting. Failing that, then in June.”
