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Rate Cuts and Inflation: How Low Do We Need To Go before We Get Chocolate Fishies?

Rate Cuts and Inflation: How Low Do We Need To Go before We Get Chocolate Fishies?

No chocolate fish were handed out with yesterday’s predictable decision from the Reserve Bank of Australia to keep rates on hold at 4.25%.

But the bank did confirm that it would wait for inflation data before considering further easing.

The RBA is expecting inflation to fall over the next quarter or two, so the question will become, how much of a fall in inflation is sufficient to justify the next rate cut?

I still think we will get two cuts this year of 25 basis points each for a total of 50 as it becomes obvious to all the RBA they are erring on the side of over cautiousness.

The external forces remain largely unchanged as far as the central bank is concerned. Europe is still a risk but the US is continuing to expand steadily and while growth in China has moderated to what the RBA calls a “more measured and sustainable pace”, their central bank also now has an easing bias with inflation now under control.

Commodity prices have likewise eased a bit but remain at “quite high levels”, but it is the high exchange rate and relative interest rates to other countries that is causing the damage in my view. Shaving rates by 50 basis points would at least remove some of the pressure for the economy.

The November and December rate cuts from 2011 have so far had little impact on the retail sector it seems. Retail sales data for February limped forward by 0.2%, suggesting consumers have better things to do with their cash than hand it over to retailers and those that are spending are doing it online or going overseas.

I think the RBA is running out of reasons to not cut interest rates but being the inflation hawks that they are, a clear signal on inflation needs to emerge before they will offer a sagging domestic economy some help.

On occasion, but not often, I think Ben Bernanke (not to mention the governors of the Bank of England, the Bank of Japan and the Central Bank of China) would make a great governor of the RBA, but as they say, be careful for what you wish for. Short cuts seldom work out over the longer term and at least when the turn in Australia’s interest rate cycle does come, the corporate sector and the economy will be well and truly ready!

Out for now…


Grant Muddle

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