RBA is doing the right thing

By leaving the short-term official interest rate unchanged at 2.5 per cent this week, the Reserve Bank has left its options open to adapt to international developments.

While the G20 meeting in Russia is unlikely to have a major impact on the world economy, the prospect of US intervention in Syria and a tapering of quantitative easing by the Federal Reserve has increased uncertainties.

If the US action in Syria further destabilises the region, the prospect is for increased cost pressures resulting from higher energy prices and an adverse impact on world growth.

The more serious concern is the impact of a reduced level of quantitative easing on the growth prospects of emerging markets. When the tapering starts, the immediate impact will be higher US interest rates, confirming increases in bond and mortgage interest rates already occurring in anticipation of the policy change. Among other things, this will result in a stronger US dollar and put downward pressure on other currencies.

The Reserve Bank has revealed its desire for a lower Australian dollar exchange rate and has been using reductions in our official cash rate for this purpose. But when US interest rates increase, there's less need for lower Australian interest rates to drive down our dollar.

Sitting on the sidelines and allowing overseas developments to bring about a lower exchange rate is a no-lose proposition. The dollar is already 15 per cent lower than at its peak against the US dollar and the combined impact of even lower Australian and higher US rates could result in a further free fall. 

A delay of one or two months in reducing our rates won't have a major impact on our growth prospects, especially now the cash rate is at historic low levels.

With action to bring the federal budget back to surplus some years away, the federal budget will continue to stimulate the economy, also reducing the need for lower rates. Nevertheless, if the federal election outcome doesn't lead to a boost in investor confidence, the Reserve Bank still has room for limited further rate reductions. 

Unfortunately, the interest rate reductions to date have done little to boost the new residential construction section of the economy.

The property action so far has been for the lower rates to boost resale prices in the existing property market, with auction clearances in the major capitals at very high levels. This preference for existing properties could be the result of high construction costs and planning and other regulatory restrictions slowing down the building process. 

Overall, with the prospect of further increases in US interest rates ahead, the Reserve Bank may not need additional rate reductions to achieve its key objective of a lower Australian dollar.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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