RBA Rates Decision – June 2012

The RBA reduced interest rates by a further 0.25% at its board meeting today, which surprised some analysts following last month’s 0.5% cut.  This move further highlights the RBA’s belief that Australia is not immune to the world financial and economic events going on around us, even though we are still very much reliant on the Chinese and other Asian partners regarding our overall trading and economic prosperity.  It’s a further move that clearly demonstrates, just as the great musical theatre production ‘Cabaret’ did, that ‘Money makes the World Go Around’.

To help me explain my little reference to the arts, I thought in this month’s commentary I’d give a bit of a ‘Cash Rate 101’ lesson to try to put the topic of Money/Finance into a more ‘lay persons’ level of understanding.  (But please understand in reality this stuff is complex and my 200 odd words don’t really do justice to what is a very detailed and complex topic that is highly debated by much more qualified observers than I).

What is the function of a cash rate?

Firstly, there are two types of money flows into an economy:

1. Fiscal policy, which in simple terms is the government’s policies and decisions around the collection of income (taxes) and the distribution (spending) of this money to influence (usually to grow) an economy
2. Monetary policy, which again in simply terms is the supply & control of cash within an economy.
   Fortunately and wisely, in Australia, our monetary policy decisions are made by an independent body (The Reserve Bank of Australia) since 1993.

The supply of money within an economy is a fantastic financial instrument that helps control the level of economic activity within an economy.  And what controls the supply of money is the cost to access this money.  If you make the cost of money expensive to borrow, then over time less supply of money comes into an economy, which usually slows it down.

So why would you want to slow down an economy?

Good question! – The reasons for slowing an economy down is all about trying to make an economy more sustainable over a longer period.  The summary benefit of a growing, yet sustainable economy is the positive impact it has on the standard of living and prolonged quality of life for the people and community which make up that economy.

When an economy grows too quickly there are inflation and potentially economic value bubbles that if they overheat or burst, will have a major impact on the people within that economy and community, via wealth depletion, unemployment, and confidence.  You don’t need to have a long memory at all to understand the impact of a failed economy; we have examples right now in Greece, Ireland, Spain etc and even the US, of economies that had poor monetary (and fiscal) policies that had impacted greatly on the people within these countries.

The RBA’s decision to reduce the cash rate (reduce the cost of borrowing money) is a monetary lever the RBA is now using, because it believes the economy is growing slowly and needs some stimulus.

A growing economy within the 3-4% level – as measured by Gross Domestic Production (GDP) is a solid indication of a healthy economy.  A healthy economy usually means that people seeking employment are able to work and the flow on income etc of this work means in basic terms the ability to be accommodated (housing), and have disposable income (lifestyle) for a moderate to good standard of living.

I mentioned earlier that the inflation data was the final confirming piece of data the RBA were waiting on for the rate move today as it has come in well below the 2-3% target range the RBA has set as a guiding principal around monetary policy.  Inflation is the hidden virus within a capitalist style economy as it makes the value of money worth less and it is the measure of how healthy an economy is in my view.  The lower the better please!

I’ve mentioned some of the indicators the RBA looks at when making their decision above, but here is a summary list for the ‘big ticket’ indicators:

• Domestic GDP
• Domestic Employment
• Domestic Inflation
• Domestic Consumer Spending
• Domestic Production
• Domestic Debt Levels
• Domestic Savings Levels
• Domestic Income/Wage Growth
• Domestic Confidence (Sentiment)
• Government and Business Capital Investment
• Balance of Trade
• Domestic Equity Markets
• Domestic Money Markets
• Global economic Outlook
• Trading Partners Outlooks
• Global Money Markets
• Global Equity Markets

It’s through the constant study of these economic indicators that the RBA bases their decision each month.  And I might be going a bit out on a limb here but Australia has enjoyed over 20 years of economic growth and prosperity and in my humble view the RBA and its board must take some credit for the sensible and strategic management of cash supply over the long term.  Sure they might have been a month late here and there with some movements but on the whole they have done a sound job.

Regarding this month’s decision to reduce rates further, it’s clearly indicating the RBA is now on an easing cycle of monetary policy to re-ignite an economy that is showing signs of slowing.  This move is a wise one, by this I mean they are not playing the wait and see game as to whether their large rate cut last month is sufficient enough or not, they are saying let’s inject cheaper money into the economy to encourage business to invest to create jobs etc, which will see the economy regain the momentum it’s losing.  And the RBA always has the luxury of putting rates up again if they do in fact over stimulate the economy. It’s better to over stimulate than under stimulate in these uncertain economic times.

 

(Those people reading this should be reminded this is an opinion comment by Ben Kingsley, and should not be used when making decisions about financial matters without seeking further clarification and understanding of your own personal circumstances.  This article is not advice you should rely upon.  I recommend you speak to one of our licensed professionals before taking any action with your financial affairs.)