RBA cuts cash rate to record low: experts react

The Reserve Bank of Australia has cut interest rates to a historical low of 2%, in its second 25 basis point cash rate cut for the year.

The move comes amid mixed economic data. There has been a recent rebound in the Australian dollar, slight improvements in the labour market, and a headline inflation rate near the the official target. But consumer sentiment has been weakening and the IMF is predicting more slowing in the Chinese economy, further weakening demand for Australian commodities.

“The Board judged that the inflation outlook provided the opportunity for monetary policy to be eased further, so as to reinforce recent encouraging trends in household demand,” Reserve Bank Governor Glenn Stevens said in a statement. Stevens also cited the drag on private demand due to weakness in business capital expenditure, as well as expectations of subdued public spending.

Treasurer Joe Hockey responded by saying now was the time for people to spend and business to invest.

“There are many green shoots in the Australian economy. This interest rate cut is going to help to facilitate those green shoots,” Mr Hockey said.

We asked experts to respond to the RBA decision and what it means for the economy, housing market and confidence.

Sinclair Davidson, Professor of Institutional Economics, RMIT:

Former prime minister John Howard’s 2004 claim that interest rates would always be lower under a Coalition government is starting to look true. Not that this is necessarily a good thing. Interest rates that are too low cause mal-investment.

The RBA is desperately trying to stimulate the economy - that much is clear. It is well-known, however, that you can’t push on a piece of string. RBA officials have been bemoaning the lack of “animal spirits” in the economy for some time now. But it isn’t the lack of finance that has caused entrepreneurs to take a much more risk-averse attitude to investment. It is uncertainty the political sphere that is causing the economy to under-perform.

Nobody can be sure what the taxation environment is going to be like over the next few years. Government has little appetite to cut spending, but can clearly get the numbers in the Parliament to raise taxes. So too investors are unclear as to the future regulatory environment. All these factors are outside the control of the RBA which must be hoping that at some point interest rates will be low enough to overcome entrepreneurial anxiety.

Richard Holden, Professor of Economics, UNSW Australia Business School:

The RBA’s 25 basis point rate cut, to 2.0%, was expected by markets but is still a signal of how fragile the economy is. Much of the RBA’s statement was taken up with discussing the status of the exchange rate and relatively subdued inflation, both of which left room for a cut.

There was a single mention of what is facing Europe and other parts of the world: “other major central banks are stepping up the pace of unconventional policy measures. Hence, financial conditions remain very accommodative globally, with long-term borrowing rates for sovereigns and creditworthy private borrowers remarkably low.” The scarier way to put it is that much of Europe has negative nominal interest rates and is teetering on the precipice of deflation and a Japan-style lost decade (or more).

The RBA’s move shows how worried it is about the global economy. And it highlights the fact that though Australia has been the world’s miracle economy since 2008, we are not immune from the global forces that could lead to a prolonged period of very low growth. Don’t be surprised if the record low interest rate in Australia gets beaten in the coming months.

Ross Guest, Professor of Economics at Griffith University

The decision today was motivated primarily by the inflation rate. At 1.3% for the past 12 months it is well below the RBA’s target 2 to 3%. The aim of lower interest rates is to lower the Australian dollar and stimulate export and import competing sectors. This will put some upward pressure on prices but that’s fine given the current low inflation rate.

Some commentators and analysts seem not to appreciate that the Australian dollar is the main transmission mechanism for monetary policy in a small and increasingly open economy like Australia’s. This is why the budget next week should not be timid in cutting government spending. Lower spending would not hurt the economy and may even stimulate it, because lower spending by government puts further downward pressure on interest rates and therefore on the dollar which stimulates export and import competing sectors. The flipside to this argument, of course, is that trying to stimulate the economy by increasing government spending doesn’t work for Australia - remember a few years ago when government spending was boosted sharply and the Aussie dollar rose to parity with the US dollar? That didn’t do much for our tourism, education or manufacturing industries.

Danika Wright, Lecturer in Finance at University of Sydney

Today’s RBA decision hurts prospective home buyers in Sydney and Melbourne. What is already a difficult situation for those wanting to enter the market puts the dream of home ownership further out of reach in those markets.

However, there is a possible silver lining. If the interest rate cut has the desired effect of boosting economic activity across the country, we could see better opportunities for homebuyers that are prepared to relocate to other cities, such as Perth.

Sinclair Davidson is Professor of Institutional Economics at RMIT University and a Senior Research Fellow at the Institute of Public Affairs. He has received funding from the Australian Research Council.

Danika Wright is affiliated with Sirca, as a member of the Sirca-RP Data Advisory Board.

Richard Holden is an ARC Future Fellow.

Ross Guest does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.