The RBA will cut, cruelly and pointlessly

In the absence of any other ideas, the RBA will keep cutting until it can cut no more; then, presumably, it will print.

The Reserve Bank will now be sorely tempted to cut rates again tomorrow, after Friday’s shockingly weak GDP in the United States.

It will be another cruel blow to retirees and have little effect on the economy, but the RBA is out of ideas. There’s nothing else it can do.

America’s growth rate in the second quarter was 1.2 per cent, half what the market had predicted, and the third consecutive quarter of around 1 per cent growth. Further rate hikes in the US have been put off.

The US dollar promptly fell and the Australian dollar popped to US76c, where it sits this morning. If the RBA does not cut tomorrow, the exchange rate will climb back towards US78c and beyond, to where it was before the May rate cut.

In fact, the cash rate is beginning to be purely a tool for managing the short-term exchange rate.

It is certainly having no effect on the inflation rate, or the economy generally for that matter. The RBA has cut the cash rate 11 times from 4.75 per cent to 1.75 per cent since 2011, yet at the same time the rate of increase in CPI has fallen from 3.5 to 1 per cent.

Of course we don’t know what would have happened without those cuts — it’s possible that we’d be in deflation now if interest rates had not been cut so much — but the national accounts show that domestic final demand, household spending and business investment have all been falling as well, so no dice there either.

In any case, it’s more likely that inflation is low for reasons other than weak demand, such as low wages growth and falling profit margins.

The only concrete achievement the RBA can cite from this five-year long rate-cut cycle is that the exchange rate has fallen from parity, as it was in late 2011, to around the US75c it is today.

But even that has largely been a function of the US dollar’s rise in anticipation of last year’s rate hike there, as well as the fall in global commodity prices.

Here’s a chart of the AUD/USD cross and the US dollar trade-weighted index that clearly demonstrates that:

Source: Bloomberg

But the Reserve Bank, along with most other central banks in the world, persist with the illusion that they are achieving something — and that they are not making retirees’ lives miserable and distorting both the property and sharemarkets for nothing.

Retirees were actually hit with a double whammy on the first Tuesday in May: the RBA rate cut that reduced their incomes and then the clamp on tax concessions in the budget that night.

The Sydney real estate market surged again in June, although falls in other cities meant the national average declined slightly, and the sharemarket had its best July in six years.

Meanwhile, private sector credit weakened in June — it didn’t grow in response to the lower price of credit.

Business credit actually fell, unexpectedly, investment loans for property are in retreat thanks to an APRA clampdown and personal credit continues to trend down.

Outgoing RBA Governor Glenn Stevens must be tearing out what’s left of his hair.

Self-funded retirees are being forced into riskier and riskier assets to try to add some meat to the three veg on their dinner plates, so the Governor and his colleagues can do their macroeconomic duty. But it’s not working.

And in the absence of any other ideas, the RBA will keep cutting until it can cut no more; then, presumably, it will print.

To not cut the cash rate tomorrow will be to invite a US80c dollar, rendering the May cut entirely pointless and “complicating” (as the RBA has been putting it for five years) Australia’s transition from mining to services.

And the disheartening thing is that those around the table know that unless the US economy starts picking up again, the 80 cent dollar will probably happen anyway, no matter what they do. It’s out of their hands.

Alan Kohler is the publisher of The Constant Investor.