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It has now been 12 months – since August 2016 – since any change was made to the cash rate.
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RBA keeps cash rate at record low, warns of higher Aussie dollar

At its August meeting, the Reserve Bank of Australia (RBA) kept the cash rate on hold, maintaining the record low. The decision was expected as Governor Philip Lowe flagged a week earlier that the rate was likely to remain the same for some time.

It has now been 12 months – since August 2016 – since any change was made to the cash rate.

So why was the cash rate kept on hold?

One factor influencing the decision was the recent surprise low inflation reading. The consumer price index rose just 0.2 per cent in the June quarter, missing expectations for a 0.4 per cent increase. This meant the headline inflation rate for the year to June 30 was 1.9 per cent – below the RBA’s target band of between 2-3 per cent.

However, in his statement accompanying the August rate decision, Lowe said the inflation data was broadly as the bank expected. He said both CPI inflation and measures of underlying inflation are running at a little under two per cent.

“Inflation is expected to pick up gradually as the economy strengthens,” Lowe said. “Higher prices for electricity and tobacco are expected to boost CPI inflation. A factor working in the other direction is increased competition from new entrants in the retail industry.”

While the RBA decided to keep the cash rate on hold, in its July meeting minutes it signalled that the “neutral nominal cash rate” is actually two percentage points higher than it is at present – that is, 3.5 per cent. This is the rate that would be needed to keep inflation in check and growth at reasonable levels.

Despite flagging this rate, there was no indication of how long it would take to get there.

In an article for ABC Online, Westpac’s chief economist Bill Evans said he believed the RBA’s estimate of this rate is too high.

“If the mortgage rate increased by a further 200 basis points, the evidence of 2011 suggests that house prices would likely fall – hardly what one might assess as a neutral policy stance,” he wrote.

Following the August rate decision, CoreLogic head of research Tim Lawless said the chances of a rate cut appear to have diminished. “However, rate hikes may be some way off as well; recent declines in the US dollar and strengthening commodity prices have placed added pressure on the Australian dollar, which may reduce export demand.”
 

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While the RBA’s cash rate does influence the interest rate that financial institutions charge for their home loans, it is not the sole decider.

What does it mean for borrowers?

One of the reasons the RBA’s monthly decision on the cash rate is monitored with such interest is that the rate is one of the factors that influences mortgage rates, so to some extent there is a correlation between the two.

The cash rate is sometimes confused with what mortgage rates should be but in effect, it is actually the market interest rate on overnight loans between financial institutions. The cash rate is used by the RBA to help manage the economy, especially with regard to inflation.

Over time, the correlation between the two has been declining and increasingly, lenders are adjusting their home loan rates independently of the RBA-defined cash rate. This has become more common since 2015, when regulatory influences have led to a tightening of lending which has in turn put upward pressure on interest rates, particularly for investment loans. Additionally, lenders’ other funding sources are impacted by a number of domestic and international economic factors, which can lead to overall funding cost movements that are out of sync with the cash rate as set by the RBA.

So while the RBA’s cash rate does influence the interest rate that financial institutions charge for their home loans, it is not the sole decider.

Why is the stronger Australian dollar a concern?

Meanwhile, the strength of the Australian dollar remains a concern for the RBA. It had been hovering around US80 cents for a week before the RBA’s cash rate announcement and rose – and stayed above – that level after the announcement.

Governor Lowe said the higher exchange rate is expected to contribute to subdued price pressures in the economy.

“It is also weighing on the outlook for output and employment,” he said. “An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.”

The Australian dollar is strengthening for a number of reasons. First there is the US dollar weakness as expectations about further Federal Reserve interest rate increases start to recede. The global economy is also expanding nicely with the International Monetary Fund recently confirming its reasonably rosy growth forecast.

What next for the cash rate?

Meanwhile, Lowe said housing market conditions were variable around the country, with prices falling in some markets. However, he added problems remained despite efforts by regulators to rein in rising levels of household debt.

The RBA’s future intentions around the cash rate were perhaps outlined in the final paragraph of its statement: “The low level of interest rates is continuing to support the Australian economy,” suggesting the rate will be on hold for a while yet.

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Gayle Bryant

Gayle has been a financial and business journalist and sub-editor for almost 30 years. She has written for a wide range of newspapers, magazines, custom and trade press and websites. Gayle’s articles regularly appear in the Sydney Morning Herald’s small business section and the Australian Financial Review’s special reports section.

The opinions expressed in this article are the opinions of the author(s) and not necessarily those of Homeloans Ltd.