Economy

The RBA Cut Interest Rates… So What?

June 9, 2019
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Reading Time: 2 Minutes

Howdy everyone!

All together for another rendition of TheFrugalSamurai?

You betcha!

Been a headline making week for us Aussies, it’s the first time our central bank (Reserve Bank of Australia) has moved the benchmark cash rate since August 2016.

With a cut in the official rate to 1.25%, this marks a historic low for our nation.

But what does it all mean?

In a nutshell, it means that the country ain’t doing so great, and that the powers-to-be decided they needed to do something to kick-start it.

Related image
Hopefully not like this.

You see, lowering rates should encourage increased investment and spending through cheaper access to borrowing.

How?

Well, in simple terms, lower rates:

Reduces the incentive to save.

Lowering rates provides a lower return from holding cash. This lower incentive encourages us to spend, spend, spend rather than holding onto money.

We might even bring forward spending by taking out cheaper loans to y’know, buy more stuff.

But the reward for keeping money in the bank decreases – that hurts our pensioners and retirees as they earn less interest on their savings held in their bank accounts.

Lowering mortgage repayments.

We’ve already seen our big 4 banks passing some or all of the rate cut onto their lending rates.

This reduces the monthly mortgage repayment, providing more disposable income for us to spend, spend, spend.

Image result for big 4 banks
But guess who really benefits?

Cheaper cost of borrowing.

Lowering rates also lowers the cost of borrowing and further encourages consumers and businesses to borrow to finance spending and investment.

This translates into higher domestic production and creates more jobs.

Rising asset prices.

When our spending rises, demand for goods begins to exceed supply, so inflation starts rising.

Which makes buying assets like shares and housing a juicier proposition.

Hence you would assume a corresponding rise in those asset prices and therefore a rise in household wealth. The increased wealth encourages everyone to spend and invest more as consumer confidence rises.

Fall in AUD.

A drop in rates means it’s relatively less attractive to have funds in Australia, which reduces the demand for Aussie dollars, which translates into a drop in currency value.

This is because from a foreign investor perspective, it is a much better proposition to be investing in a country yielding higher returns elsewhere.

Although a falling currency is good news for exporters, because as the value of AUD falls, their customers (foreign importers) can buy more from them.

The converse is true for Australian importers (more expensive).

As exporters benefit, they ramp up production, which creates more jobs, which creates more wealth, which creates more spending, and so on.

Image result for self perpetuating cycle
Kinda like this amazing insight.

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It’s important to bear in mind that of course, as with everything – there is a LOT of external factors at play.

I’ve always taken the view that a cut in the official cash rate means that the underlying economy is not doing too good, no matter how positive the media or politicians spin it.

With all the talk of a global slowdown, it’s not like our domestic economy is coming from a position of strength heading into the next couple of years.

I’d argue that it makes our economy riskier, chiefly because there is even less wriggle room for our central bankers to play with if things really do hit the fan.

Which is why I’m hoping the RBA acted in time to fend off that dreaded “r” word.

Radiation?

Um no.

Recession.

Anyway, we’ll see won’t we guys… until next time!

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