Another Cash Rate Cut this May

6a00e5521d07838833017ee843cb77970d-800wiLast February, the Reserve Bank of Australia had made a decision to lower the cash rate by 25 basis points to 2.25 per cent.  On Tuesday, 5, May, the RBA had announced that there will be another cash rate cut by 25 basis points to a record low of 2 per cent due to a mixed bag of performance in economic indicators, effective on Wednesday, 6 May.

Having anticipated the marginally improving unemployment data from 6.2 per cent in February to 6.1 per cent in March, the RBA held the cash rate in April. In addition, it was suggested that the employment rate decreased as a result of people getting hired, as opposed to falling out of the labour force. This is reflected by the increase in participation rate by 0.01 percentage point.

However, the decline in the balance of trade and the country’s inactive GDP growth rate of 2.5 per cent for the year to November 2014 was considered. These are evident signs that the mining industry is now falling behind even as it had kept the economy afloat during the GFC.

Having the inflation below the RBA target band of 1.3 per cent in February is another factor for the recent cash rate cut.

Commodity prices were boosted in April. Iron ore price lingered at US$60 at the end of April, thus increasing 25 per cent over the month.  Crude oil prices also escalated sharply in the first quarter of the year, and by the end of March, it stabilised around US$52. Because of this and due to the fact that the oil price is linked with LNG production, higher revenues were projected by exporters of liquefied natural gas.

Recently, AUD rose and closed at US 78 cents on 4 May, due to the relatively weak performance in the US, and quantitative easing programmes weakening the euro and the yen. This growth in AUD had become another contributing factor in the recent rate cut decision.

So what happens now?

Since the AUD has a lower rate of return, a lower cash rate will help reduce the increase in dollar. As we all know, a strong dollar would otherwise impede the demand for Australian tourism and education, and the growth in export. These two industries are among the major sources of economic growth in Queensland.

However, considering that interest rate being an important stimulant in the Australian economy, a rate cut may also cause further pressure on house prices in the already unaffordable market of Sydney, which projected a median house value in March of $928,000.00.

Dwelling construction has increased notably in Victoria, where dwelling approvals increased 20 per cent in February. This is also virtually similar to all states where there is high density dwelling construction and thus generating a leading employer and economic growth driver in New South Wales, Queensland, and Victoria.

Still, as soon as the demand for housing shifts into the correction phase of the cycle, employment in dwelling construction, as it did with mining construction, is likely to diminish. Hence, there is no guarantee that dwelling construction will be a sustainable path for a long term economic growth.

Australia’s highest performing housing market generated lower growth rates after having the rate hold in April. As opposed to 3.55 per cent in February, Sydney houses progressed 3.88 per cent in the March quarter. Hence, instead of being able to stimulate the economy in other areas, a cut in the cash rate might further extend this growth cycle.

Furthermore, the government faces a hindrance in generating other forms of economic growth through fiscal policy due to the large budget deficit. Consequently, RBA took added pressure to aid economic growth through a rate cut this May.

Do you think this month’s cash rate cut is justified?

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