Reserve Bank has left room to cut interest rates

While the Reserve Bank’s decision yesterday to leave interest rates on hold at 3% may have disappointed some in the business community, the RBA indicated more rate cuts could still come.

RBA governor Glenn Stevens said while growth was likely to be a bit below average this year, there were encouraging signs that last year’s rate cuts had so far had the desired effect.

Stevens pointed to the rate cuts the bank made between May and December last year, which he described as “a significant easing in monetary policy”.

The RBA believes the hefty cuts which reduced interest rates from 4.25% to 3% are still filtering through the economy.

Inflation is sitting at around 2.25%, which Stevens says is “consistent with the medium-term target”, indicating there’s no barrier to further rate cuts.

Indeed, some of the factors keeping inflation down, such as weakness in the jobs market, are keeping rate cuts on the agenda.

The governor said the downside risks to the global economic outlook have abated “for the moment at least”, encouraged by Australia’s trade deficit narrowing to $427 million in December from $2.8 billion in November and an average of $2.1 billion in the five months to November, as China rebuilt iron ore stocks, and as heavy machinery imports slowed.

From the RBA’s point of view the new year has started positively, giving it a bit of breathing space to decide whether further rate cuts are really needed.

But the RBA clearly left the door open for further rate cuts, with Stevens saying “the inflation outlook … would afford scope to ease policy further, should that be necessary to support demand”.

Another rate cut is something many in the business community are pushing for, with CPA Australia chief executive Alex Malley accusing the RBA of “sitting on the sidelines” and Australian Retailers Association executive director Russell Zimmerman calling for interest rates to be cut to 2.5%.

Importantly, the RBA suggested Australia’s banks should be able to pass on more of any future rate cuts.

“Sentiment in financial markets has continued to improve, with risk spreads narrowing and funding conditions for financial institutions becoming more favourable,” Stevens said.

Clearly the “cost of funding” excuse banks have been using to justify not passing on the previous rate cuts in full is starting to wear a bit thin.

With financial markets pricing in a 52% probability of a rate cut next month, the RBA has given itself some room to move and signalled its intention for any rate cut to be passed on in full.