Why did the RBA cut rates and what does it mean?

Our regular Q&A columnist, Greg McKenna, the Markets & Economics Correspondent for Business Insider Australia gives us his insights into the latest rate cut.

 

I’ve been writing recently that the Australian economy was growing and businesses were reporting solid conditions, confidence was reasonable, and profitability and trading were looking pretty healthy. Likewise I’ve been saying that there are more Australians in work than ever before and that helps the Australian economy because all those people earning income means consumer spending and confidence should remain strong.

And around 60% of traders, market economists, and forecasters thought the RBA would hold fire and leave rates at 2%.

But the game changed with the release of first quarter CPI in late April. Headline inflation fell by 0.2% for the quarter, leaving the annual increase at just 1.3%. Not only was the quarterly decline the largest since the December quarter 2008, it left the annual increase at the lowest level since the June quarter 2012.

Markets had been expecting an increase of 0.2%, leaving the annual increase unchanged at 1.7%.Core CPI, the bit that takes out the volatile stuff like petrol and fruit and vegetable was also lower than expected. That means for the first time in its inflation targeting history this measure of inflation was below the bottom of the RBA’s 2-3% target band.

As a result the RBA cut rates by 25 basis points to 1.75%. Yet the release of the minutes to this month’s RBA board meeting show clearly the cut was not about growth. The minutes reflect “in coming to their policy decision, members noted that developments over recent months had not led to a material change in the outlook for economic activity or the unemployment rate, but the outlook for inflation had been revised lower”.

That suggests the RBA knew it had little lose – in terms of a destabilising acceleration in inflation – by cutting rates and as a result took out insurance for the economy against global forces of deflation by deciding to take the risk of let the economy run a little hotter in the current environment. As long as it doesn’t spook consumers that’s a good thing for the economy and Business.

There remains little chance of a recession in Australia anytime soon. But low wages growth and the forces of global deflation mean that a theme I have been talking about for years – slow but steady growth – looks like it is becoming entrenched. As long as consumers and business calibrate for this future they will continue to enjoy the benefits of a relatively strong economy.

 

Greg McKenna is an economist, trader and adviser. He runs his own consultancy and writes for Business Insider Australia. You can find him on Twitter @gregorymckenna or at www.gregmckenna.com.au

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