RBA slashes interest rates to record low of 1.75%

The Reserve Bank has cut the official cash rate to a new record low of 1.75 per cent at its May board meeting.

The announcement, made just hours before the 2016 Federal Budget announcement, follows 12 consecutive months with interest rates on hold at 2.0 per cent.

Following the RBA’s previous announcement to leave the cash rate unchanged at its April board meeting, economists and academics predicted there would be no movement in the cash rate in the foreseeable future with the majority agreeing that Australia is at the bottom of the cycle.

However, subdued inflation pressures and a weak first quarter for consumer prices saw some economists revise predictions.

Also read: Australia’s best performing state revealed

Ahead of the announcement, 10 out of 15 economists forecast that rates would be held for another month, while markets predicted a 58 per cent chance of a cut, according to AAP.

The central bank hasn’t cut rates since last May and upon holding rates steady at its meeting in March, RBA governor Glenn Stevens noted there were reasonable prospects for continued growth in the economy, with inflation close to target.

He said the board would judge whether the improvement in labour market conditions was continuing and whether the recent financial turbulence portended weaker global and domestic demand.

Since then, data shows that consumer prices unexpectedly fell 0.2 per cent in the March quarter, which was well below the bank’s 2.0-3.0 per cent target band.

The RBA has consistently said that continuing low inflation would allow a rate cut that should be appropriate to lend support to demand.

Economists argue that demand is still strong enough, with employment falling to 5.8 per cent in April and the economy growing 3.0 per cent last year.

The RBA decision to cut the cash rate to a new historic low today of 1.75% was likely to be hotly debated at the board meeting held today, said CoreLogic RP Data research director Tim Lawless.

“On one hand we have economic growth tracking at 3% per annum, a housing market where the pace of capital gains is moderating in a controlled fashion and relatively strong labour market conditions,” he said.

“Balance this with negative quarterly inflation and a high Australian dollar and it becomes clear that this decision probably could have gone either way.”

He adds that the big question relevant to the housing market is how much of the lower cash rate will be passed on to mortgage rates. 

Also read: A cheat sheet for reading the federal budget

The spread between the cash rate and standard discounted mortgage rate has been widening since 2008 when there was 1.8 percentage points difference between the two rates. 

By the April 2016 the spread has doubled to be 3.65 percentage points and is likely to widen further if the full rate cut isn’t passed on by lenders to mortgage rates. 

“With home values still showing some upwards momentum, lower mortgage rates are likely to provide some further stimulus to the housing market, which the Reserve Bank will be monitoring closely,” Lawless said.

“The last thing they would like to see is a rebound in the rate of capital gain, particularly in Sydney and Melbourne where dwelling values have already risen 50% and 31% respectively since the rate cutting cycle began in November 2011.”

 

Glenn Stevens, Governor: Monetary Policy Decision

"At its meeting today, the Board decided to lower the cash rate by 25 basis points to 1.75 per cent, effective 4 May 2016. This follows information showing inflationary pressures are lower than expected.

"The global economy is continuing to grow, though at a slightly lower pace than earlier expected, with forecasts having been revised down a little further recently. While several advanced economies have recorded improved conditions over the past year, conditions have become more difficult for a number of emerging market economies. China's growth rate moderated further in the first part of the year, though recent actions by Chinese policymakers are supporting the near-term outlook.

"Commodity prices have firmed noticeably from recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years.

"Sentiment in financial markets has improved, after a period of heightened volatility early in the year. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues. Funding costs for high-quality borrowers remain very low and, globally, monetary policy remains remarkably accommodative.

"In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom. GDP growth picked up over 2015, particularly in the second half of the year, and the labour market improved. Indications are that growth is continuing in 2016, though probably at a more moderate pace. Labour market indicators have been more mixed of late.

"Inflation has been quite low for some time and recent data were unexpectedly low. While the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.

"Monetary policy has been accommodative for quite some time. Low interest rates have been supporting demand and the lower exchange rate overall has helped the traded sector. Credit growth to households continues at a moderate pace, while that to businesses has picked up over the past year or so. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

"In reaching today's decision, the Board took careful note of developments in the housing market, where indications are that the effects of supervisory measures are strengthening lending standards and that price pressures have tended to abate. At present, the potential risks of lower interest rates in this area are less than they were a year ago.

"Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting."