Why interest rates will keep falling

Today we saw the Reserve Bank cut the official cash rate again by 0.25%, pushing rates down to a new record low of 1%.

But despite those all-time lows we believe investors can expect rates to fall even further.

Wait and see

The RBA’s decision to cut rates follows its move to lower rates by 0.25% to 1.25% in June – the first cut since August 2016.

The RBA is concerned that unemployment is too high. It wants to reduce unemployment to stimulate wages growth and inflation. The June cut was unlikely on its own to achieve that objective.

The RBA will probably now sit back and wait to see the impact of the two cuts they’ve put through in the past few months.

More cuts to come

But we do expect another cut later this year and then probably another cut early next year, ultimately taking the official cash rate down to 0.5%.

There are a number of reasons why we believe more cuts are on the cards:

• While the Australian economy is growing, and is not in recession, growth is running well below potential. Since the June cut we have seen softish jobs growth and GDP numbers.
• We think that unemployment will drift up a little bit from here to 5.5% by year end, which will act as a dampener on wages growth. 
• At the same time, the downturn in the housing sector is affecting growth. While house prices seemed to have bottomed, we’re still seeing weakness emerging in housing construction and that obviously flows through to the broader economy.
• Weak housing, sluggish growth and rising unemployment all come at a time when there are risks to the global economy, including the US/China trade war and tensions with Iran.
  

All of those factors will keep economic growth somewhat constrained and therefore ultimately see the RBA cut interest rates further.

What does that mean for investors?

While recent gains in Australian shares leave them vulnerable to a short-term pull back, we remain optimistic on shares on a six to 12-month view, in part due to easing by central banks like what the RBA is doing now.

The likelihood of further RBA cuts to the official cash rate, taking them as low as 0.5%, means cash and bank deposits are likely to produce poor returns.

And with the RBA set to cut rates more than the US Federal Reserve, the $A is likely to fall further to around US$0.65 this year

So, while the latest RBA decision to cut rates has seen them fall to record lows, investors should consider factoring in even more cuts in the next six to 12 months.