RBA keeps rates on hold for May

Rates on hold

At its May board meeting we saw the Reserve Bank leave interest rates on hold. However, we think the central bank is still likely to move on interest rates sooner rather than later.

Interest rates, of course, have now been on hold continuously since August of 2016, which was the last time the RBA moved on interest rates.

Wait and see

We thought there was a good chance they could cut rates given the risks in the Australian economy, softer inflation numbers and global uncertainty.

But in the event the RBA probably decided that, in the midst of an election campaign, it was best not to politicise the setting of interest rates. They probably also decided to wait and see what fiscal stimulus results and what happens to unemployment.

Still heading down

But we still see the Reserve Bank cutting interest rates in the months ahead. We have seen quite a sharp slowing in the Australian economy, much weaker-than-expected inflation forecasts, and global uncertainty, not least of which are concerns around trade between China and the US.

So all those factors means that ultimately we think that we will see the Reserve Bank cut interest rates, probably down to 1% by the end of the year, with the first move probably being straight after the election in June.

Consumer spending boost

There will be a lot of debate about whether those interest rate cuts will help the economy. I think it will provide a bit of a boost for two main reasons.

Firstly, it should help boost consumer spending.

If you think about someone out there with a mortgage – perhaps someone who has recently taken out a loan and still has a high mortgage -- they’ve seen house prices falling in Sydney and Melbourne and are probably feeling a bit negative about things.

If you cut their interest costs and they can pay off the loan faster, it will help them feel more confident and probably stops them cutting back on their consumer spending.

That depends, of course, on whether the banks pass on the rate cuts. They will be under a lot of pressure to pass them on. And I think they will pass them on for the simple reason that recently, their cost of funding has come down a bit.

Aussie dollar stimulus

Secondly, lower rates put downward pressure on the $A because Australia becomes less attractive for investors to park their money. A falling $A helps the economy because it makes it easier for companies to compete internationally, and also brings more students to our universities and more tourists to Australia.

Avoiding recession

Ultimately the rate cuts will help the Australian economy when they are delivered, most likely in the months ahead sometime after the election.

When combined with fiscal stimulus, stronger infrastructure spending, a bottoming in mining investment, a pick up in non-mining investment, and hopefully stronger global growth, rate cuts will prevent the Aussie economy slowing down too much. And they will almost certainly prevent Australia sliding into recession.