March Interest Rate Outllook by Maquarie Research

􀂃 We review the outlook for interest rates following the Reserve Bank of
Australia’s (RBA) decision to leave interest rates unchanged following its
March Board meeting.
Impact
􀂃 The RBA’s decision to leave the cash rate unchanged at 3.25% in March
indicates that it is sufficiently confident in the resilience of the Australian
economy – which “has not experienced the sort of large contraction seen
elsewhere” – to risk further undermining sentiment. But in our view, this
marks a temporary pause in the rate cutting cycle, rather than its end, with a
weakening labour market eventually forcing the RBA to cut rates to 2½%.
Analysis – The ECB is no role model for central banks
􀂃 It is not good enough for a central bank to say that because its official interest
rates are already low, it has done enough to support the economy. This is the
mistake that the European Central Bank has consistently made, with the
result that the economy is much weaker now than it needed to be. This also
has the implication that policy will eventually have to be loosened even more
aggressively due to the weakened state of the economy.
􀂃 As shown in the chart opposite, while the RBA’s official cash rate is already
well below its recent trough in 2001, lending rates (ie mortgage and business
loan rates) are only around the same level as in 2001, when the headwinds
facing the domestic economy were significantly less, confidence was stronger,
and the health of the financial sector was significantly better.
􀂃 In that light, there appeared to be a clear case for cutting rates further now.
This is particularly evident given the RBA Governor Glenn Stevens’
observation that Australia is facing a crisis of confidence as well as a credit
crisis. Any perception that the central bank has ‘thrown in the towel’ – that is,
accepted that lower interest rates wouldn’t help the economy, or that the
economy doesn’t need help – would be particularly damaging to sentiment.
􀂃 Another argument for doing nothing is that a further rate cut wouldn’t help.
However, there is no evidence to support this assertion. There are now firm
signs that people are beginning to return to the housing market, and by
making lending even more attractive, further rate cuts should both bring
forward the timing of the recovery, as well as the ultimate size of the
improvement.
􀂃 To be sure, retail banks are warning that they might not fully pass on further
RBA rate cuts, however, this argues for the RBA doing more rather than less.
And to the extent that bank balance sheets are improved by wider margins,
then this is also beneficial.
􀂃 As such, we do not find the reasons for leaving rates unchanged compelling,
and think that this represents a pause in the rate-cutting cycle, rather than its
end. To be sure, the RBA is very sensitive to a rising unemployment rate, and
this could be the next trigger for lower rates. Alternatively, any sign that
housing lending or retail sales – both of which have shown signs of life
recently – were beginning to capitulate would also force them to resume the
easing cycle.