RBA custs the cash rate to new record low

The Reserve Bank of Australia (RBA) today cut the cash rate to 1.75% from 2%. This was most obviously in response to the recent very weak inflation figure, but actually is due to many factors. The statement by RBA governor Glenn Stevens pointed to a number of reasons but showed that downward pressures on inflation exceed upward pressure. These influences can be seen as demand side or supply side influences.

Downward pressure on inflation:

Demand side

* The global economy is continuing to grow, though at a slightly lower pace than earlier expected,

* Conditions have become more difficult for a number of emerging market economies.

* China's growth rate moderated further in the first part of the year,

* Uncertainty about the global economic outlook and policy settings among the major jurisdictions continues.

* GDP growth picked up over 2015, particularly in the second half of the year,  Indications are that growth is continuing in 2016, though probably at a more moderate pace.

* Credit growth to businesses has picked up over the past year or so.

* Appreciating exchange rate.

* Housing market, price pressures have tended to abate. 

Supply side

* The economy is continuing to rebalance following the mining investment boom.  

* Ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world. 

Upward pressure on inflation: (All demand side)

* Commodity prices have firmed noticeably from recent lows,

* Sentiment in financial markets has improved,

* Lower exchange rate overall has helped the traded sector.

* Credit growth to businesses has picked up over the past year or so.  

Although there are always opposing forces acting on inflation, when the pressure in one direction is significantly higher the central bank must change interest rates, The real question is why has the RBA waited so long to act. Interest rates take two years to work through the economy to affect inflation, so this might be too little, too late? 

It is probable that the RBA were concerned that low interest rates would cause house prices in Sydney and Melbourne to rise even faster. 

The RBA statement is here

 This post is of critical importance to VCE students who must be aware of and be able to apply all of the forces determining Australian monetary policy decisions. For VCE students the reasons that interest rates have been set is an excellent example of the application of monetary policy.