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Interest Rates: They Might be Hitting Bottom

Rates hit bottom but hikes not imminent

Reserve Bank Board meeting

•    The Reserve Bank (RBA) has left the cash rate unchanged at a 49-year low of 3.00 per cent.
•    The RBA has removed its easing bias (inclination to cut rates). For the past two meetings, the RBA indicated that there was scope to cut interest rates further. Now the RBA says that monetary policy is “appropriate given the economy’s circumstances.”

What does it all mean?
•    You know that the domestic and global economies are doing better when the Reserve Bank stops talking about further rate cuts. The $64 million question is when will the RBA start removing the massive stimulus in place?
•    This is the hard part for policymakers. It’s easy to cut rates when you know the economy needs a kick along. It’s a far harder task to judge that the economy has recovered sufficiently to allow rates to start lifting again to more ‘normal’ levels. But it’s clear from the latest statement that the economy is not at that point yet. CommSec doesn’t expect rate hikes to begin until 2010, but it is far too early to define a time for the first move.
•    The RBA has carefully crafted its latest statement. While the Bank has made it clear that rates have bottomed for now, it is certainly not suggesting that rate hikes are imminent. The RBA says that credit conditions are difficult, that risks to the global outlook have not disappeared and that domestic inflation should fall further.
•    The RBA has clearly toned down its upbeat rhetoric, making sure it doesn’t give the impression that it will be hiking rates any time soon. While economic conditions “have been stronger than expected” the RBA is warning of some hangover effects as the government’s stimulus spending works its way through the system. The RBA would want to ensure that the economy could stand on its own two feet, that is, without being propped up by the Government, before deciding to lift interest rates.
•    The last rate cut was in April 2009, and with the RBA now signalling that further rate cuts are unlikely, speculation centres on when the first rate hike will occur. In December 2001 the RBA cut rates to a low of 4.25 per cent and then issued the first rate hike six months later in May 2002. In the two previous cycles the gap between the last rate cut and first rate hike was a little longer. It was a break of 11 months in 1999 and a gap of just over 12 months in 1994.
•    As the Reserve Bank Governor said last week, there are no rules with monetary policy. It has been noted in the past that monetary policy is art, not science. Interest rates are at 49-year lows and the longer that they remain super-low, the greater the risks of imbalances developing such as a housing bubble. But the RBA doesn’t want to derail an economic recovery in Japan style.

Interest rate decision and past cycles
•    The Reserve Bank has kept interest rates on hold at a 49-year low of 3.00 per cent.
•    The cash rate of 3.00 per cent is the lowest since February 1960 when the short term money market yield averaged 2.94 per cent.
•    Consistent data on short-term money market rates extends back to August 1961. Before August 1961 there were minimum and maximum short-term money market rates. In February 1960 the simple average cash rate stood at 2.94 per cent.
•    Before the first rate cut back in September 2008 there had been twelve rate hikes in the cycle extending back over five years (since May 2002), the last occurring on March 5 2008. Over that period, rates lifted 3 percentage points to 7.25 per cent. In the period since, cash rates were sliced by 4.25 percentage points – the most aggressive easing cycle ever undertaken.
•    Monetary policy is clearly expansionary. Now the Reserve Bank is deliberating how and when to start removing monetary stimulus. The Reserve Bank has indicated that the “normal” or neutral cash rate is around 5.25 per cent. A neutral cash rate means that monetary policy is neither expansionary nor contractionary.

What are the implications for interest rates and investors?
•    A period of interest rate stability lies ahead – clearly positive for the economy. A period where there is less focus on the monthly Reserve Bank meeting will allow people to get on with their lives.
•    The RBA hasn’t indicated that rate hikes are imminent. But if the improvement in economic conditions continues then rate hikes will gradually draw nearer. Borrowers shouldn’t wait until rate hikes are imminent, but rather start planning now for higher rates ahead.
•    Financial market pricing points to the first rate hike occurring in 6-9 months.
•    The Reserve Bank will have a lot of work to do in coming years in getting monetary policy settings back to “normal”. Borrowers should expect that eventually cash rates will need to rise around two percentage points.
•    The latest RBA Board statement should prevent consumers and businesses from getting too far ahead of themselves. The RBA is working on the principle that recovery will take time, with many challenges ahead.
•    The RBA has indicated when rate hikes will occur – when the global economic recovery becomes durable, and that requires balance sheets getting back to normal. Unfortunately there is no further detail on what this means.

Source Savanth Sebastian, Economist, CommSec

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posted in Finance, Home Loan, Loan by Finance Help

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