Thursday, October 4th, 2012
On the 2nd of October 2012, RBA has announced a quarter of a percentage point cut to the official cash rate bringing the cash rate down to 3.25 per cent. The Bank made references to global factors when explaining their reasons for the rate cut: “At today's meeting, the Board judged that, on the back of international developments, the growth outlook for next year looked a little weaker, while inflation was expected to be consistent with the target. The Board therefore decided that it was appropriate for the stance of monetary policy to be a little more accommodative.” RBA next meeting date is on November 6 2012.

The main question to consider is whether this latest rate cut is good for the Australian Economy. Is a lower cash rate in the current environment likely to help or hurts the economy. The overall level of bank deposits is currently very close to the amount of outstanding loans. Furthermore, home borrowers are very much in debt reduction mode opting to pay off loans quicker rather than take on more debts. Retailers only hope is that a stronger global economy offer improved consumer confidence, more jobs and more consumer spending. As long as consumers remain in saving mode, the Australian retail sector continues to bleed.

Will a rate cut do the trick?

The Reserve Bank was lucky enough to be able to safely reduce rates. The Australian budget deficit is slowly addressed so the federal fiscal policy is certainly contractionary. While inflation is under control many sectors of the local economy are suffering. RBA is hoping that lower rates will provide some level of insulation to local businesses from overseas economic issues.

However while rate cuts have historically been very effective in stimulating consumer demand and economic activity, the situation today is more ambiguous.

There are 2 sides to rate cuts. They assist borrowers at the expense of savers and are therefore viewed as a tool to encourage more spending and less saving. The number of savers has soared n recent months and currently deposits are sitting very close to loan levels. Bank deposits represent around 90 per cent of loans outstanding, well up from 75 per cent just five years ago.

According to statistics only one third of Australian families are home owners and therefore they are the main beneficiaries of any rate cuts. Renters may benefit as well but the impact will be a long term one rather than immediate.

The non-home buying public tend to be savers rather than borrowers. So a rate cut will hurt all the families living off interest income. It will encourage these people to invest in growth assets and possible borrow.

The question remains how to reignite consumer confidence. If people don’t have the confidence to spend and instead continue to save and pay off home loans at a faster rate, then the rate cut is unlikely to generate the required result and several large rate cuts may be needed to move the consumer. What is important about the interest rates is their general position rather than specific numbers. Currently interest rates are sitting well below longer-term averages. The concern is that borrowers will apply any rate savings to reducing existing loans and debts rather than increase spending.

Retailers are complaining that the Australian consumer is in an extended sleep period however statistics demonstrate that they are spending but not the way they used to. They are looking for value propositions choosing to spend on local holidays instead of going overseas and buying clothing on-line rather than in department stores or local boutiques. Will interest rate cuts change these habits? Probably not.

Each year over the past several years November was the month that RBA had chosen to move interest rates. Does this mean we are in for another rate reduction next month? The Reserve Bank still believes rate cuts act to boost growth and it doesn’t tend to move rates just once. Further, the global environment remains weak and good inflation data is expected later this month.

Historic Rate Cycles

The RBA has reduced our cash rate by 25 basis points (quarter of a per cent) to 3.25 per cent. The previous rate reductions were three months earlier in June (25 basis points), May (50 basis points) and then back in November and December 2011 (each by 25 basis points).

In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. This is almost like the floor level and we have not seen rates move below this level in any recent The Reserve Bank now assessing the current variable home loan rates in relation to their normal levels. Today the variable home loan rates are around 6.85 per cent for most mainstream lenders - well below the long-term average rate of 7.20 per cent. Clearly there is more room to reduce rates n order to increase consumer stimulus and hopefully revive confidence.

What can we expect in the near future?

The Australian consumer is moved to invest and spend by their perception of a bright economic future and their levels of confidence rather than the level of interest rates.

If the rate cut encourages borrowers to pay down debts( ) and loans ( )at a faster rate while savers experience lower interest rate income, then potentially a rate cut will not have the effect desired by the RBA.

Contact Profile

Yana Kuprienko

P: (03) 9563 8698


australian economy, rate, RBA, rate cut, loans , home loans



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