What the interest rate cut means for the economy and for you

The Reserve Bank of Australia (RBA) has announced a cut to the official interest rate – the first cut for almost three years. The 0.25 basis point cut brings the official cash rate down to 1.25 per cent.

The decision reflects concerns about the economic outlook, wages growth and inflation.

Reasons behind the decision to cut

We have recently seen slower economic growth due to the housing downturn and there are concerns more generally about the global environment and its impact on Australia.

There are also increasing signs that unemployment has bottomed and is starting to rise again at a time when the RBA really needs lower unemployment in order to drive both wages and inflation up.

More cuts to come?

We expect that, ultimately, there will be more cuts ahead.

We see the RBA ultimately cutting the cash rate down to 0.5 per cent by mid next year because we don’t think one or two cuts will be enough to drive the stronger growth in the economy required to get unemployment down and inflation up. Ideally, future cuts will also be combined with fiscal stimulus policy from the Government.

Who are the winners and losers?

While interest rate cuts are often welcomed they are not good news for everyone.

People with money in bank deposits such as self-funded retirees relying on bank interest for income will be hurt by interest rates remaining lower for longer.

The key for those investors is to seek advice on other investment options that might provide them with a higher income flow, whilst also balancing any additional risk that might require against the absolute security of bank deposits.

However, mortgagees will benefit from lower interest rates which could allow them to pay down their debts faster. They’re the group that changes their spending the most based on overarching economic conditions so I think the cut will provide a little bit of help for the wider economy.

Lower interest rates will also help keep the Aussie dollar down and Australian companies probably need that to get a bit of a boost when it comes to competing internationally.

The cut should also help the housing market find its bottom, however it’s unlikely to set off another housing market boom, due to household debt being substantially higher than in the past, tighter bank lending standards and the chance of rising unemployment.