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Where to from here for interest rates?

At its February 2016 board meeting – the first of the year – the Reserve Bank of Australia kept the cash rate on hold. While the decision to hold was expected, there was disappointment from some quarters about the lack of any signal around potential rate cuts, considering the volatile global markets, China concerns and falling commodity prices.

In the RBA’s statement, governor Glenn Stevens said one of the reasons for keeping the cash rate on hold at 2% was that the RBA believed there were “reasonable prospects for continued growth in the economy”. Because he feels there are reasonable growth prospects, there was no need to lower the cash rate to encourage consumers and businesses to spend.

Stevens added, “financial markets have once again exhibited heightened volatility recently, as participants grapple with uncertainty about the global economic outlook and diverging policy settings among the major jurisdictions”.

 

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Westpac chief economist Bill Evans said the latest statement reaffirmed his view that rates would remain on hold throughout 2016 but added it was significant that global financial market conditions had been raised as an important factor in the board’s thinking.

The target cash rate has been kept the same since May 2015 and the RBA’s comments suggest it is unlikely to make any changes this year, not least because the falling Australian dollar has boosted the competitiveness of the economy. Many of the cuts to the cash rate were carried out in order to achieve a lower Australian dollar.

The dollar has been trading around US70 cents, down from US90 cents just 12 months ago. A lower dollar makes goods and services relatively cheaper for international buyers and this can boost Australia’s exports.

Meanwhile, house-price growth is slowing, which is putting paid to speculation that a housing bubble is occurring and taking pressure off any need to increase rates.

 

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Other factors are also feeding into the “hold for now” decision. Inflation experienced a slight rise in December from 1.5% to 1.7% but this remains well within the bank’s target range of between 2-3%. The unemployment rate is also reasonably low – coming in at 5.8% in January. Inflation and unemployment are two key factors the RBA takes into consideration when deciding whether to raise or lower rates and as neither is causing any undue concern, the RBA appears content to keep things as they are.

However, there are factors making people ask whether cuts are needed. Last year, Stevens told central bank watchers to “chill” over the question of further rate cuts but the recent volatility, plunging commodity prices, China concerns and falling consumer sentiment have increased speculation that rate cuts could be a possibility.

 

Will rates go up?

But while all eyes are generally on the RBA when it comes to the direction of interest rates, last year’s events – when banks raised rates independently of the RBA – showed this situation is changing.

The Australian Prudential Regulation Authority introduced regulatory changes for lenders in 2015 and this has had an across-the-board effect, for example, in banks’ funding costs, which in turn has affected mortgage rates for investment properties.

 

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As the lenders’ funding costs rise, there is talk that more interest rate rises will occur this year to compensate, even if the RBA doesn’t move on the cash rate. Any rate increases by lenders is something that is likely to be a key consideration for the RBA in its decision about the direction of the cash rate.

So will interest rates go up this year? Some believe this is likely as lenders continue to feel the effects of APRA’s regulatory changes. However, the slowing housing construction boom, low wages growth, global market volatility and continuing concerns around China may prompt the RBA to cut rates at least once this year.

Looks like it’ll be another year of watching and waiting for rate movements (or not).

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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.