To Cut or Not to Cut? Which way for interest rates?

Graeme Salt

To cut or not to cut? The first Tuesday of the month is when the Reserve Bank’s Board meets; it is a date that we at Origin Finance follow closely. This Tuesday is a line ball decision as to whether the RBA cuts interest rates or not. While the cash rate is at an historic low of 3 per cent, some analysts are saying it should go even lower and the central bank should continue an easing cycle that has seen rates fall by 175 basis points since November 2011. At the same time, other economists expect the RBA to wait until June to make a move. Some are still confident it will keep rates on hold for the rest of the year. There are even some economists who say that the next rate move will be up. However, predictions about an end to the Reserve Bank’s easing cycle in the past two months have diminished in recent weeks after a spate of weaker-than-expected economic data. Financial markets are pricing in a 53 per cent chance the Reserve Bank will reduce rates by 25 basis points on Tuesday, and are expecting the cash rate to fall to at least 2.5 per cent by the end of the year. So with the 50-50 chance the central bank could cut rates next week, what are the arguments for and against bringing the rate down to 2.75 per cent? The strongest case supporting a rate cut is the low inflation, but there are also questions about the strength of the housing recovery, which the RBA believes will compensate for a weakening resources sector. Indeed, according to RP Data, April saw a 0.5 per cent drop in dwelling values. Another factor that could push the Reserve Bank to lower rates is the higher unemployment rate, Low inflation – the March quarter consumer price index (CPI) figures showed that the inflation rate is comfortably within the RBA’s target band of 2 to 3 per cent. Unemployment rate is rising – and is now at highest in three and a half years Weak economic data – such as a contraction in the services sector in April; a fall in Australian residential building approvals and limited growth in private sector credit in March; Growth slowing globally – we may have seen a relative stock market boom but there is still a lot of inconsistency out there. The US has experienced a period of growth but has had trouble sustaining it; the ECB has just had to cut rates; and China appears to have lost momentum as its economy moves from being export-based to one which is focused on the domestic consumer. Strong dollar – every export based business seems to be struggling. But there are also quite a few reasons for the Reserve Bank not to cut rates next week Earlier rate cuts seem to be working – the RBA has consistently said that it is beginning to see the fruit of its endeavours, particularly with green shoots in the property market. Unemployment is still healthy compared to other countries – 600 full-time jobs and 45,200 part-time positions were created between January and March despite a rise in the unemployment rate. Retailers are more optimistic – rate cuts often drive consumer confidence and the RBA said recently: “Global growth is forecast to be a little below average for a time, but the downside risks appear to be reduced. … Around Asia generally, growth was dampened by the earlier slowing in China and the weakness in Europe, but again there are signs of stabilisation.” If you are thinking about rates, bear in mind two things 1.Over the lifetime of a loan, borrowers on a variable rate tend to do best 2.If you want to hedge your bets, splitting your loan so that it is part fixed and part variable will help you factor in possible rate cuts or rate rises.