Reserve Bank cuts rates to 1.75%
Concerned about a weak first quarter inflation read, the Reserve Bank of Australia has cut the cash rate by 25 basis points to 1.75%.
PT1M41S 620 349Has the RBA been spooked by the perceived spectre of entrenched deflation? Does Glenn Stevens have nightmares about Australia falling into a longer term deflationary rut like Japan? And is all deflation or falling prices of goods and services bad? Yes, maybe and no.
There have been plenty of economists around this week happy to fall into line with the central bank's decision to cut interest rates to an all-time low of 1.75 per cent, based on the weak inflation numbers released last week.
But the fact that, until the rate decision was made, half the economists were predicting rates to hold suggests there are plenty of experts quietly scratching their heads about the RBA's decision. All agree that, for those who sit around the table at the central bank, the call on rates would have been a tight one.
Little return: There were plenty of economists around this week happy to fall into line with the central bank's decision to cut interest rates to an all-time low of 1.75 per cent, based on the weak inflation numbers released last week. Photo: Glenn Hunt
The aim of the RBA's move is to ignite some demand, to get people and companies spending, but it's questionable if the rate cut will achieve this objective.
To a significant extent, the falls in prices that led to inflation falling off a cliff in the March quarter were not the result of a lack of demand but increased supply and/or increased competition from businesses looking to increase market share.
We know from the inflation data that prices of fruit and vegetables and fuel were the biggest drivers of the result. Both these were driven by supply factors: there was a booming harvest in fresh produce and the international oil price remained particularly weak during the March quarter mainly due to supply.
Neither of these categories are particularly influenced by a lack of demand. Coles and Woolworths sales results that cover the March quarter have demonstrated clear evidence of significant price deflation (decrease in price) in the average basket of groceries. It was about 2.5 per cent in Woolworths' case.
But this deflation was induced by these large supermarket companies looking to take market share from each other and protecting their share from the growing competitor, Aldi. In all but Woolworths' case, sales revenues are growing (even after taking into account lower prices).
Another deflating category is communications. It has been well documented that phone companies have been fighting for market share by discounting voice and data plans and, to some extent, increasing handset subsidies.
Meanwhile, in clothing and footwear, the fall in March pricing was most primarily the result of post-Christmas sales. Normally these prices bounce back in the June quarter.
One of the few economists who publicly disagree with the RBA's fear of inflation is the Commonwealth Bank's chief economist, Michael Blythe. He surmises that the decision to cut rates ... "indicates a level of concern about the inflation trajectory that looks overdone, in our view".
He questions the downside of good price deflation, the kind that results from competition pushing prices down. He suggests that many of the price falls were the result of new supply coming onstream rather than a shortage of demand and thinks some of these weaker prices may reverse in the next quarter.
It's a view not shared by all. The AMP's Shane Oliver, who had been arguing that the RBA needed to lower rates, sees lower inflation as a more broad-based problem. He points to the fact that inflation has been trending down for a while and the big jolt down in the March quarter pushed the RBA to act.
"While it would be wrong to conclude that Australia is on the brink of sustained deflation – as falls in petrol and fruit prices won't be repeated – the big surprise in the March quarter inflation data was that price weakness was broad based with underlying inflation running at its lowest annual rate on record," Oliver said.
But proponents and detractors of the RBA's move on rates generally agreed there is nothing in the central bank's statement on Tuesday that suggests it is particularly concerned about how the broader economy is travelling, other than perhaps sluggish wages growth.
So what's the downside to lowering interest rates, even if it proves to be unnecessary or at least premature?
Some say little. But that is a strange argument to mount when the central bank's monetary ammunition is so depleted. With an interest rate at 2 per cent (which it was before the cut), the RBA had little scope to move the interest rate lever down if the broader economy started to decline. Shooting a blank or taking an air shot now is just a waste.
Another risk is that people will place their money into riskier investments such as property or the share market, given that the returns from safe havens such as deposits are pitifully low. Already rental yields on property in Sydney and Melbourne are better than bank deposits.
A rate cut can also send a signal to the community that the economy is weak, and thus damage consumer sentiment, Blythe says.
And from a business perspective, the RBA has made it pretty clear that cutting interest rates has done little to promote additional capital expenditure.
Clearly the RBA has decided that attempting to cut deflation off at the pass is a more prudent course than waiting to see what happens to the next set of Consumer Price Index numbers.
"When you break into deflation like Japan [has], you have the problem that people delay spending because they think prices will be cheaper in a month's time, so it's better to wait. And companies don't bother to invest because the assets they buy will go down in value."
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