The Reserve Bank of Australia took markets by surprise on Tuesday by cutting its benchmark rate by 25bps, citing weakening inflationary pressures as the main reason for the move. The central bank lowered its cash rate for the first time in 12 months from 2.00% to a new historic low of 1.75%.
Although many analysts had expected for the RBA to resume soon with its rate cutting cycle, following much weaker-than-expected quarterly inflation figures out last week, the consensus was the RBA would wait and assess the situation before taking action this month. The unexpected move triggered a sharp drop in the Australian dollar, which slumped by almost 2% against its US counterpart immediately after the announcement. The aussie had edged up to just above the 0.77 level before the decision in anticipation of rates being held steady. But it fell to a low of 0.7555 within minutes of the announcement.
In the accompanying statement, RBA Governor Glenn Stevens said recent inflation data had been unexpectedly low and other indicators are also pointing to a lower outlook than previously forecast. Comments on growth and the labor market were not very positive either.
Economic growth is likely to be more moderate in 2016, and despite the recent rise in commodity prices, Stevens said Australia’s terms of trade remain “much lower than they had been in recent years” given the extent of the commodity price fall. Stevens also sounded less optimistic on the labor market, describing recent data as “mixed”.
Another concern for the RBA is the Australian dollar, which had appreciated by 7% since the beginning of the year and before last week’s losses. A stronger exchange rate would dampen inflationary pressures further and hurt the country’s exports. However, there were no strongly worded warnings against an appreciating currency, only that it could “complicate” the rebalancing of the economy.
One noticeable change though in today’s statement was that the Board no longer sees the overheated housing market as an obstacle for further rate cuts. Recent regulatory changes to the supervision of mortgages have capped lending and house prices are not rising as rapidly as before. Stevens noted that “the potential risks of lower interest rates in this area are less than they were a year ago”. This could potentially pave the way for future cuts if the downside risks to inflation increase further.
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