Frank Uhlenbruch, Investment Strategist in the Australian Fixed Interest team, discusses the Reserve Bank of Australia’s (RBA) rate cut to a post-war low of 1.25%, what it means for fixed interest markets and the broader economy.

The RBA cut the cash rate from 1.50% to 1.25% in line with earlier signalling. The current easing cycle started in November 2011 when the cash rate moved from 4.75% to 4.50%, with the most recent cut in August 2016 when the RBA cut from 1.75% to 1.50%.

Of the major banks to have moved, standard variable mortgage rate cuts ranged between 18 and 25 basis points (bps).

Key points from the June RBA board meeting

• The Australian Economy: The economy is expected to grow around 2.75% in 2019 and 2020.
• Household consumption: The consumer outlook remains the main source of domestic uncertainty, but the RBA expect some pick up in household disposable income to support consumption.
• Labour market: While it has performed well, the rate of absorption of spare capacity has slowed more recently, with the neutral unemployment rate below 5%.
• Housing market: The adjustment in established housing markets is continuing, though in some markets the rate of price declines has slowed and auction clearance rates have increased. Mortgage rates remain low and there is strong competition for high quality borrowers.
• Inflation: Inflation outcomes were lower than expected and suggest subdued inflationary pressures. Inflation was expected to gradually lift over the outlook period. Core inflation of 1.75% is expected by the end of 2019, lifting to 2% in 2020 and a little higher after that. June quarter headline inflation will be boosted by higher petrol prices.
• Today’s decision is about making further inroads into the spare capacity in the economy and assisting with “faster progress in reducing unemployment and (achieving) more assured progress towards the inflation target”.

How the market reacted

• The market reaction was rather muted. Markets had discounted an easing today with most of the focus on the extent and strength of any forward guidance.
• On that front, the RBA were circumspect, but noted that they will continue to monitor labour market developments closely and adjust monetary policy to support sustainable growth.
• At the time of writing, three and 10 year government bonds were 1bps lower in yield at 1.11% and 1.49%. After an initial lift in the Australian dollar to $US0.6993, the Australian dollar eased back to $US0.6977, while the S&P/ASX 200 Index lifted from 6,325 to 6,342 post the announcement.

Chart 1: Australian cash rate and 30-day interbank futures contact (%)

Source: Janus Henderson Investors, Bloomberg.

What we think

• We see some merit in the RBA pausing after today’s move to give it time to assess whether some of the more recent slowing had a ‘deferral component’ as economic agents waited to see the outcome of the election.
• As the RBA noted, it appears as though activity levels have picked up in key property markets and stabilisation in house prices would see an end to the negative wealth and confidence effects from falling house prices.
• That said, we still have an August easing in our base case which will round out a pro-cyclical pulse of complementary policies that include:
  •  50bps of monetary easing in total;
  • a relaxation in macro-prudential settings;
  • tax cuts worth around 0.5% of GDP (similar impact to two rate cuts); and,
  • a 3% boost to the minimum wage following the latest Fair Work Commission decision.
• These should help support the economy as the housing sector cools and there is scope for growth to surprise on the upside over the second half 2019 if we get a return to more normal seasonal conditions and as the drag to growth from the completion of large LNG projects ends.

Views as at 4pm, 4 June 2019.