RBA slashes interest rates

Fear of deflationary spiral has compelled the RBA to act, risking a politically charged spike in house prices.

Fear of a job-destroying deflationary spiral has compelled the Reserve Bank to cut interest rates to a new historic low of 1.75 per cent today, risking another politically charged spike in house prices and bounce in household debt.

As journalists begin to pore over Scott Morrison’s first budget in Canberra, due for release tonight, the Reserve Bank Board has announced it will cut the cash rate below 2 per cent, dragging the Australian dollar down in afternoon trade.

At 3.35pm (AEST), the local unit was trading at US75.67c, while the benchmark S&P/ASX 200 index had surged 1.9 per cent.

The currency was trading at US77.07c immediately prior to the decision, while the sharemarket was up 0.5 per cent.

Meanwhile, National Australia Bank announced within minutes of the decision that it would pass on the 25 basis point reduction in full. Shortly afterwards, Westpac also announced a reduction in its property and small busines loans by the same amount.

Despite a falling unemployment rate and above average economic growth, a shock 0.2 per cent fall in the consumer price index over the first three months of the year convinced the Board to cut interest rates for the first time since May last year.

“Inflation has been quite low for some time and recent data were unexpectedly low,” RBA governor Glenn Stevens said in a statement.

“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.”

The decline left the annual inflation rate, even stripping out volatile items, at 1.6 per cent, far below the Reserve Bank’s minimum target level of 2 per cent and the lowest rate in at least a decade.

Despite trillions of dollars of monetary stimulus and record low interest rates since the global financial crisis, consumer price inflation has remained very low throughout advanced countries. The IMF has routinely marked down global growth forecasts.

Meanwhile, Prime Minister Malcolm Turnbull seized on the Reserve Bank’s comments about the weakening housing market to attack Labor’s negative gearing policy.

“The housing market is trending downwards -- a correction, you might think -- but you have to ask yourself: why would Australians risk a kick-in-the-guts to the housing market right at the point where it’s vulnerable?” the Prime Minister told parliament.

“The governor’s remarks … support the economic case that the government is making, support our commitment to strong growth and jobs, and continuing the successful transition from a mining-construction boom to a more diverse economy.”

The RBA’s decision will put pressure on Australian banks, which have been raising their key lending rates in recent months, to cut their business and lending rates by 0.25 percentage points.

It also casts doubt on the strength of Australia’s economy, which grew 3 per cent in 2015 but faces challenging global conditions this year as China’s economy slows and the US recovery falters.

Mr Stevens said signs were pointing to a slowdown in growth this year, which likely factored into the decision.

“GDP growth picked up over 2015, particularly in the second half of the year, and the labour market improved,” he said.

“Indications are that growth is continuing in 2016, though probably at a more moderate pace.

“Labour market indicators have been more mixed of late.”

Also pushing the Reserve Bank to cut was the recent surge in the Australian dollar, with Mr Stevens saying the appreciating exchange rate “could complicate” the rebalancing of the economy at the end of the mining investment boom.

House prices remained at the forefront of policymakers’ minds, but a recent cooling of the market compared to the stunning growth of recent years led the central bank to believe the risks had lessened.

“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,” Mr Stevens said.

“At present, the potential risks of lower interest rates in this area are less than they were a year ago.”

The RBA’s decision came despite reports of resilient business confidence and conditions yesterday both in and outside the mining sector, and the unemployment rate falling to a 2.5-year low of 5.7 per cent in April.

It also follows on the heels of strong building approvals numbers this morning.