The Experts

What were the main reasons behind the RBA rate decision today?

The RBA cut the cash rate by 25 basis points today. The Bank cited the need to stimulate the broader economy as the level of resource related investment starts to wane. Although the past rate cuts were still working through the economy, the RBA stated that the inflation environment afforded scope for further stimulus to be added.

Can the RBA afford to cut rates (further) to get the Australian economy going?

The RBA does have the capacity to further reduce rates, and the shape of the forthcoming Federal Budget will play a critical role in determining the extent, if any, and timing of further RBA moves.
 
What effect would a rate cut/further rate cuts have on the high Australian dollar?

Immediately following the RBA decision the AUD was about half a cent weaker. The AUD has shown increasingly over the past several months that interest rates are less of a factor than previously. A possible explanation is that the AUD is increasingly a reserve currency and as such is less driven by interest rate differentials.
 
What is the RBA's view on the Australian economy, and its outlook?

The Bank is becoming increasingly concerned about successfully negotiating the transition from a resources investment led economy to more broad based growth. Managing this transition was always going to be problematic, the RBA has taken out insurance to assist in this smooth transition.

The Bank is attempting to stimulate other sectors of the economy, such to maintain the momentum in the economy as the sources of growth transition.
 
What are the main concerns for the RBA at the moment?

The Bank is concerned that the labour market could deteriorate and that the lead time for other sectors of the economy to pick up is extended. Hence they have taken advantage of the inflation outlook to reduce the cash rate. Importantly, the Bank noted that it was appropriate to use some of the scope afforded by the inflation outlook. This suggests that they may consider further rate cuts in the period ahead.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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What were the main reasons behind the RBA's rate decision today?

The RBA left the cash rate unchanged at its meeting today. The Bank cited the ongoing flow on effects from the rate cuts over the second half of last year, as providing momentum for other sectors of the economy to progressively take over as mining investment activity declines to more normal levels. These improving domestic fundamentals together with broadly positive trends in international markets meant that the Board was comfortable to sit tight for the present.
As the Bank noted, “The inflation outlook affords the scope to ease further should that be necessary to support the economy in the event domestic demand weakens.”

What effect did global issues such as Cyprus and the impact it may have on Europe have on the rate decision?

The Bank largely looked through the recent events in Europe. The Bank noted that while Europe remained in recession, growth in both China and the US remained moderately positive. The Bank acknowledged that re-establishing sustainable paths for both public and private sector finances in a number of countries, largely European, remains challenging. As a result, global financial markets remain vulnerable to setbacks arising from specific factors.

What are the local economic indicators is the RBA watching?

The Bank, for the past several months, has been focussing on the speed and breadth of the flow on effects of previous rate cuts through the economy. While the timing of these effects is likely to be drawn out, it appears that the early stages of the transition from an investment led economy to a more balanced growth profile is starting to emerge. The Bank cited the improvement in consumer sentiment and housing, as examples. More broadly, consumer sentiment has increased over recent months as the uncertainty surrounding Europe has receded, and the domestic factors turn positive.

What is the RBA's view on the Australian economy, and its outlook?

The Bank is reasonably confident on the status of the economy. The challenge for the Bank is getting the timing right. As the economy transitions, there may be a need for further monetary stimulus, however, the lagged impact of interest rate changes makes it difficult to get the outcome correct with precision. The Bank acknowledges this, when they commented, “The Board will continue to assess the outlook and adjust policy as needed (up or down, our emphasis) to foster sustainable growth in demand and inflation outcomes consistent with the target over time.”

What are the challenges right now for the Australian economy?

The challenge for the Bank is to manage the transition to more broad based growth across multiple sectors of the economy, from the current domination of mining related investment spending. In this regard housing and consumer spending will play key roles.

What were the main reasons behind the RBA's rate decision today?



The RBA left the cash rate unchanged at 3 per cent today. The bank cited the combination of the following factors as contributing to their decision:

• Improving global sentiment


• Leading to stronger equity markets, while commodity prices remain at reasonably high levels.


• The domestic market appears to be beginning to respond to prior cuts in interests rates over the second half of last year; and
• Dwelling investment is slowly starting to pick up.

 
 


What effect did global issues (US, China and Europe) have on the rate decision?

The Bank noted that the previous clouds that had dominated international financial markets over the past year or two, have started to lift. The US is expanding, financial strains in Europe have significantly improved, China continues to experience robust growth and broader Asian growth has stabilised. These elements have all contributed to an improved global picture, which will provide support for the Australian economy via resource related demand.
 
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What is the RBA keeping an eye on in regard to local economic indicators and global issues?



The RBA has stated on several occasions that the peak in the investment phase of the resources boom is approaching, as this occurs there will be scope for some other areas of demand to strengthen. The interest rate decreases from last year were designed to support those sectors of the economy. The inflation outlook provides scope for the Bank to further adjust rates if additional stimulus is required.
 


The RBA will be monitoring growth in the demand for credit, currently it is lower than the RBA would prefer.
 


The Bank also acknowledged that financial markets will continue to be subject to occasional setbacks in the recovery process. 
 
 


What is ING Direct's prediction for further rate cuts/rises over the this year?

The global and domestic economy have entered 2013 with a significant improvement in both business and consumer confidence. Against this background, it is acknowledged that the RBA is nearing the end of the current interest rate cycle. As noted by the Bank the inflation outlook provides the Bank with scope to further adjust rates should the need arise. In the absence of volatility, it is reasonable to expect the RBA to be on hold for an extended period, although it is possible they may provide a final interest rate cut in the June quarter.



What is your outlook for the Australian economy?

As noted above the flow on effects of past interest rate reductions are starting to filter into the domestic economy. This together with the improved global outlook suggest that  the outlook for the Australian economy is sound. The challenge for the economy will be in the transition from an economy fuelled by investment spending to a more broad based economy with activity levels in the non resource sectors responding to the interest rate cuts. The measure of success of this will be in labour market data and in particular the composition of employment growth between full time and part time employment.


What is ING Direct's outlook for the Australian dollar?



The AUD has traded within a comparatively narrow range over the past several months broadly 1.02/1.05.
 
With interest rates on hold, potentially for an extended period, there remains a strong interest rate differential in favour of the AUD. This differential together with the improved global outlook, suggests that the AUD will continue to be well supported in the period ahead.


What were the main reasons behind the RBA's rate decision today?

The RBA noted in its decision that the outlook for the global economy had improved over the Christmas period. This improved sentiment, together with the rate reductions over the second half of 2012 have provided the necessary stimulus for the domestic economy. The Bank indicated there was sufficient momentum in the economy at the present time. Notwithstanding the decision today, the Bank indicated that the most recent inflation reading provided scope for further adjustment of monetary policy should circumstances dictate.


What effect did global issues (US, China and Europe) have on the rate decision?

To the extent that the tone in offshore markets has improved over the summer, the RBA took this as a positive indicator of domestic prospects over the near term. However, events in the past few days  ( possible change of governments in both Spain and Italy), indicates the fragile nature of the European recovery.

What is ING Direct's prediction for further rate cuts/rises over the this year?

Given the improved sentiment in both onshore and offshore markets, it is likely the cash rate may be nearing, (if not already at), the low point in the current cycle.
The announcement late last year that the Government was moving away from its balanced budget objective indicates that the previous pressure on monetary policy has eased, with scope now available for fiscal policy to provide stimulus to the economy.

Will the Australian dollar remain high for some time?

The AUD has been stubbornly locked in a narrow range just under 1.05 for an extended period. Given global interest rates remain at around zero, the attraction of AUD fixed income investments remains. In addition, improving global prospects will underwrite ongoing demand for Australian resource related exports. Further, the additional productive capacity that has been built up in the resources sector over the past few years is now coming on stream.
These factors combined will underpin the AUD in the near term.


What is your outlook for the economy?

The domestic economy appears to have commenced 2013 in a positive mood. A combination of offshore events, led by equity prices, stronger domestic equity prices and the improving tone of the housing market is expected to see business and consumer confidence improve over the next few months.
 
This is a key turnaround for the economy; and to the extent this continues over the next few months the overlook for the domestic economy has also improved.
 
The impact of the early announcement of the election date is a potential unknown, although, hopefully this will not derail activity in the domestic economy.


What were the main reasons behind the Reserve Bank's (RBA) rate decision today?

In their assessment the global outlook has slightly improved over recent months. The RBA is concerned about domestic sources of inflation and as the positive impact of the higher exchange rate begins to wane, they emphasised a need to improve productivity to counter domestic sources of inflation.

Also the previous adjustments to monetary policy are still working their way through the system, and these appear to have begun to have an impact on domestic activity.

What is ING Direct's prediction for further rate cuts/rises over the next year?

In the absence of adverse market developments, we anticipate the RBA will be on hold for a period into 2013.

What effect will this have on the Australian dollar? Do you think it will remain high for some time?

The immediate response has been for the AUD to trade higher around US$1.04. The unchanged rate environment, and an improving global outlook, will underpin the currency in the near term.

What is your outlook for the economy?

Broadly the economy is expected to be steady, although month to month unemployment may be slightly higher, more so as a result of variation in the participation rate as opposed to a deterioration in labour market conditions.

Domestic sources of inflation are a potential concern, as these have been running at above four per cent. If the exchange rate effect is reduced in keeping measured inflation within the RBA target band, the Bank may, subject to broader domestic and global conditions, be forced to take pre-emptive action.

As the global environment improves, consumer sentiment should also improve, given the battering it suffered over the middle part of the year.

Despite the RBA seeing the resources boom levelling out slightly earlier than expected, the volume effects will continue on into the future.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

For advice you can trust book a complimentary first appointment with Switzer Financial Planning today.

Following a combined 75 basis point reduction in the cash rate over the past two months, the RBA left the cash rate unchanged at its meeting on Tuesday.

This outcome was completely in line with market expectations.

Key points from the RBA statement

The RBA noted there had been “a material easing in monetary policy over the past 6 months”.

While there was “no change in the Bank’s inflation outlook”, “maintaining low inflation over the longer term will, however, require growth in domestic costs to slow as the effects of the earlier exchange rate appreciation wane”.

This point highlights the RBA concern on two fronts, namely domestic inflation and productivity.

The chart below highlights that domestically sourced inflation has been running at an annual rate of over three per cent for the last several years. While the strength of the appreciation of the currency has seen the price of imported products fall over this period.

This combination has resulted in overall measures of inflation being at the lower end of the RBA two to three per cent target range.

The Bank noted that the terms of trade have most probably peaked; as a result further strong appreciation of the currency is unlikely.

Therefore, overall measures of inflation will drift higher in the absence of the currency induced cushion.

In recent speeches the Bank has highlighted the poor productivity growth that has beset the Australian economy over recent years.

Growth in productivity is an effective means to combat domestic sourced inflation.

Equally, the comments from the Bank regarding domestic cost pressures is a warning sign that, in the longer term, they may be prompted to use monetary policy to reign in excessive domestic cost pressures. This is someway off at this stage, but it does highlight the RBA thought process.

Key events since the last RBA Board meeting

Domestic

Immediately following the RBA Board meeting in June, when the RBA cut the cash rate by 25 bps, significantly stronger than expected growth and labour force data was released, surprising markets.

The RBA noted, in the subsequent Minutes, that the June decision was finely balanced.

In hindsight, this would suggest that in view of the stronger than expected underlying economic data, the RBA may not have cut rates in June.

This interpretation would appear to be reinforced by the comments in the statement on Tuesday “there has been a material easing policy over the past 6 months”.

The Bank is highlighting that adjustments to monetary policy involve a substantial lag prior to having a material impact on the real economy. The lag is variously estimated to range from six to nine months.

This stimulus effect is compounded with the expansionary impact of the cash disbursements under the family assistance package. While this funding is designed to primarily offset the costs associated with the carbon pricing scheme, it nevertheless provides a net stimulus to the economy.

In addition, the cessation of the temporary flood levy will see more money flow into consumers’ wallets. The question is, will this be spent or saved?

Global

For most of the past month, it appeared that events were going from bad to worse, as the ongoing European crisis engulfed the Spanish, and to a lesser extent, Italian banking system.

Despite this impression, a number of positive developments occurred over the period;

•  Greek elected, at a second attempt, a pro-European government and affirmed the terms of the previous funding packages.
• The European leader’s summit, held at the end of June, was being seen in the same light as previous meetings; lots of talk but seemingly no real progress. Hence, low expectations were held. In contrast, Europe agreed on a framework to separate banking issues from sovereign debt concerns. As always with these plans not only is the devil in the detail, but the implementation risks remain elevated.

Global Events 

The economic environment has changed significantly over the past few months.

The election results in both Greece and France have further heightened the sovereign debt crisis in Europe. The failure to achieve a working government in Greece means that new elections will be held in mid-June, this will serve to further drag out the current uncertainty.

The second election in Greece is being seen as a referendum on support for the austerity programs and, in effect, continued membership of the EUR.

The prospect of the exit of Greece from the EUR has increased against this backdrop. However, the reality is that Greece and, as a result, Europe cannot afford for Greece to exit the Europe.

While the Greek electorate may be voting against a known future of quantified austerity measures, exiting the EUR would result in voters facing an extended period of deep economic recession with a particularly uncertain future. Social unrest would immediately follow.

Spain is the latest European country in intensive care. The banking system is under severe pressure as the combined impact of mounting bad debts, largely through property loans, and deposit outflows take their toll. The Government’s budget position does not provide scope for it to effectively rescue the banking system. Therefore, in all likelihood Spain will require international assistance accompanied by further austerity measures.

The recent G8 meeting expressed very strong support for Greece remaining in the EUR. Despite the current political posturing, it appears likely Greece will remain in the EUR, although the ongoing uncertainty will contribute to market volatility.

Elsewhere across the globe, concerns have emerged about growth in China and the potential impact on commodity prices.

Recent forecast suggest China’s economy will grow by around 7-8% over the year ahead. Although slower than recent years, the slower pace has been the result of deliberate policy action by the Chinese government. 

The challenge for the Chinese economy is to engender domestic growth in the face of a weakening global environment. In response to the weakening environment, monetary policy in China has been eased to facilitate this repositioning.

Despite the short term pessimism regarding Chinese growth, the more likely scenario is that the pipeline of infrastructure projects currently underway and, in prospect, in China will provide a solid foundation for the future. In turn, this will underpin demand for commodity exports from Australia.

US growth continues to improve with the recovery becoming more broad based. Reflecting the comparatively insular nature of the US economy, it is largely immune from event in Europe.

Clearly, European volatility will dominate markets for the period ahead. On balance, we believe that stability will emerge over the northern summer as the election uncertainty in Greece recedes and their commitment to EUR and austerity measures is reaffirmed despite protests. 

Domestic Economic Considerations

The benign inflation result for the March quarter, together with the slowdown in domestic credit growth in both the household and business sectors in recent quarters, paved the way for the Reserve Bank to cut the cash rate at its May meeting by 50 basis points. 

While the market had anticipated the easier tone from the RBA, expectations were focussed on a more gradual trajectory. 

Housing mortgage interest rates were subsequently reduced by around 30/40 basis point, as banks sought to recover margin eroded through higher funding costs. 

The surprise move by the RBA saw the AUD come under selling pressure.

Subsequent events in Europe, revisions to the global growth outlook and weaker commodity prices have seen further weakness in the currency. The AUD is currently around .97, slightly above an 8 month low.

The response in interest rate markets has been to sharply increase expectations of further significant interest rate cuts in the period ahead. 

At its June meeting the Reserve Bank reduced the cash rate by 25bps to 3.50%. 

The Bank cited the need to insulate the economy from international events as the main driver behind the decision. The Bank noted the deterioration in financial market sentiment over the past month and that households and businesses continue to exhibit precautionary behaviour. 

Previously the Bank had commented that, due to the positive inflation outlook, it had significant scope to further adjust policy in the event global and or domestic factors warranted such a response.

Currently, the futures market suggests that the 90 day bill rate will reach a low of around 2.75%, compared with the current rate of 3.4%. This compares with 4.05% at the end of April.

In the absence of a major deterioration of events in Europe this would appear to be overdone.

Despite all the noise, the fundamentals for the Australian economy remain very positive, although uneven. The dichotomy in the economy is an inevitable outcome from the strong growth in the resources sector, diverting resources and exposing other sectors of the economy to the impact of the higher exchange rate.

Implications for Borrowers and Investors

Reflecting the very strong expectations of sharp cuts in official interest rates, market interest rates are at record lows across the yield curve.

This provides great opportunities for borrowers to lock in the current low fixed rates. From a budgeting viewpoint, it is a good idea to have around 50/75% of a mortgage on a fixed rate basis for a term of say 3 years. This provides a high degree of certainty in relation to monthly repayments. The remainder of mortgage remains at the variable rate, such that if these rates move lower, the client enjoys some of the benefit. Equally, if variable rates increase the client is well protected.

Given the historically low level of absolute rates, this appears to be the prime time to look closely at locking in fixed rates.

From an investor viewpoint, while absolute rates have moved sharply lower the intense competition for term deposits has cushioned the decrease in rates. In this environment, investors are taking advantage of floating rate debt instruments. The benefit of these products is that it locks in the current wide credit spreads without locking in the low absolute rates.

As floating rates start to increase over time, the return to the investor is further enhanced, in addition to the current wide credit spreads. Hence, the absolute return to the investor increases.

At its meeting today, the Reserve Bank Board left the cash rate unchanged at 4.25 per cent.

In contrast to previous months, this outcome was widely anticipated by financial markets.

In an unusual move, the Board telegraphed very clearly their intention at next month’s meeting.

“The Board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices (due April 24) to reassess its outlook for inflation, before considering a further step to ease monetary policy.”

This is a significant change from the Bank’s commentary in previous months and it is a first for several years where the Bank has forecast so clearly their next policy change.

The Bank recognised that sectors of the economy were under pressure, with the prospect that growth will be somewhat below trend over the year. It appears the Board is gaining confidence that inflation will remain well behaved in the period ahead and not be an impediment to further downward adjustment in the cash rate.

Given this outlook, it could be argued the RBA should have adjusted the cash rate at this meeting rather than waiting the additional month. Sectors of the economy would argue very strongly that this was a missed opportunity.

While global conditions have settled considerably over the first quarter of the year, especially compared with the back half of 2011, the RBA acknowledges that Europe will remain a potential source of adverse shocks for some time to come.

In this regard, unemployment in Spain is estimated at 23 per cent, with youth unemployment at over 50 per cent. Similar statistics are being repeated across several Southern European countries, and it is this aspect that could trigger further social and political unrest, particularly as various countries move into election mood.

Bank funding conditions

The improvement in market sentiment in wholesale funding markets evident in January and February continued into March.

Despite the improvement in funding conditions, the cost of funds remains at elevated levels compared with average levels over the previous 12 months. In this context, it will be interesting to see if banks adjust their rates independent of the RBA.

It should be noted that the move to reprice the asset side of the balance sheet away from RBA interest rate decisions, largely reflects the practice that has occurred on the liability side of the balance sheet for several years. Deposit rates, including term deposits, have been adjusted to reflect banks relative demand for funds measured against competitors.

Regulators are increasingly requiring banks to generate term liabilities, the cost of which is less directly influenced by short-term cash rates. Therefore, it follows that the impact of the cost of longer-term deposits will have an increasing influence on the overall cost of the funding mix.

Impact on interest rates

Despite the above comments, it is unlikely banks will adjust rates this time around. However, if, as appears likely, the RBA reduces the cash rate in May, it may be the case that banks will seek to retain some of the reduction to cover the, still high, cost of wholesale funding.

Investors and depositors continue to be winners

Regardless of future moves by the RBA, and responses by the banks regarding mortgage rates, deposit products will continue to be an attractive destination for investors.

Notwithstanding the improvement in funding conditions in wholesale markets, competition in the retail sector for deposits remains intense.

This is a continuation of trends evident over the past couple of years as banks adjust their funding models in anticipation of the regulatory changes that are on the horizon.

Against this background, combined with the underperformance of both the property and equity sectors over recent years, suggests that a fundamental transformation in asset allocation is underway.

Investors are looking for certainty of attractive returns rather than the uncertainty of could be returns.

This trend will accelerate as the aging of the population dynamic comes increasingly into play.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

For advice you can trust book a complimentary first appointment with Switzer Financial Planning today.

The past six months have been dominated by financial events in Europe, although this could be viewed as a story in two halves.

During the December quarter, the European crisis was perhaps at its most intense, with considerable speculation the EUR currency group would dissolve in a disorderly manner. The March quarter, in contrast, witnessed a number of positive developments that culminated in breaking the negative sentiment which heavily influenced markets during the December quarter.

In particular:

• The successful completion of negotiations to release further funding assistance to Greece.
• Agreement from bondholders to restructure their Greek debt obligations.
• Agreement across a number of countries to introduce measures to address fiscal imbalances.

While none of these measures or agreements were new or unexpected, in fact a number had been on the table for several months, the real accomplishment was reaching agreement such that they could be finalised.

A key contributor to the change in sentiment was also the successful three-year repurchase transaction executed by the European Central Bank in December. This effectively alleviated the near term funding pressures facing a number of banks. A further transaction was undertaken at end February.

If market conditions require there is scope for a third repo to be executed into the June quarter. Some commentators argue this assistance simply puts off the inevitable for three years.

In contrast, we suggest that this provides the markets with a necessary circuit breaker to buy time for the combination of measures to have a positive impact on broader financial markets. While there is a risk it may come to same failed outcome, it was necessary to allow time for the other measures to have an impact.

Electoral cycle and implementation risks

The implementation risks on the European rescue and reform packages are formidable.

Across Southern Europe as a whole, nations are being forced to introduce significant fiscal reforms, which have grown out of historical excesses, in a very condensed timeframe. This is leading to social unrest.

Combined with the electoral cycle in these countries, the political landscape is shifting to right wing nationalist parties. If these parties are successful, the implementation risks surrounding these austerity programs will be escalated. 

Broader global growth considerations

In contrast to the bleak growth that appears likely for Southern Europe in particular and Europe more broadly, growth prospects on the other side of the northern hemisphere have brighten considerably over the past several months.

A wide range of US economic indicators have surprised to the positive over the period. Importantly, it appears employment data has begun to improve, with potential positive flow on effects to consumer sentiment and spending.

Despite these early positive indicators the recovery in the US remains fragile; however, it is gaining momentum at each turn.

Growth in Asian economies has been, to date, little impacted by European events. To ensure their economy remains on a solid platform of seven to nine per cent growth, Chinese officials have eased monetary policy via adjustment to required reserves.

As the rebuilding efforts gather momentum in Japan, the increased activity is expected to be reflected in growth number over the first half of 2012. Despite this improvement recovery in Japan will still be hampered by fiscal imbalances.

Commodities prices, since the beginning of the year, appear to turned and broken a clearly defined downtrend evident from the second quarter of 2011. 

Australian growth considerations and implications

Despite the global volatility over the second half of last year, domestic economic growth remains on track.

Reflecting the weakness in Europe consumer and business confidence eased into yearend. Employment was flat over calendar 2012. Resources and related sectors continued to outperform other sectors of the economy. The number of major new projects, and the quantum of funds invested continues to increase at a solid pace.

Although the retail sector struggled in 2012, broader measures of consumer spending recorded reasonable growth.

Inflation remains well contained and provides scope for the RBA to further adjust rates should domestic demand conditions unexpectedly deteriorate.

Australia will continue to enjoy impressive growth in actual, and especially, comparative terms. While the Europe and the US are expected to grow at below trend levels, Australia will continue to evidence above trend growth driven by ongoing demand from Asia and a recovering US economy.

Clearly, the high level of the exchange rate is impacting those non-resource-related industries subject to import competition. This is part of the fundamental shift that is occurring in the economy as the impact of the resources boom and high commodity prices transforms the economy through exchange rate linkages. 

What does this mean for the RBA?

In response to the deterioration in Europe over the December quarter and more importantly prospects for global growth at the time the RBA cut the official cash rate by 25 basis points in both November and December.

Despite higher funding charges, banks in the main passed on the full amount of decrease to housing loan interest rates.

At the time, the markets feared a deep extended recession in Europe with the potential for a disorderly unravelling of the EUR.

Reflecting these concerns, the market was arguing that the RBA would cut rates by around 75 basis points over calendar 2012. This is reflected in implied interest rates derived from the interest rate futures markets.

At its February meeting, the RBA noted the combination of the significant improvement in global sentiment and the impact of previous rate cuts paved the way for the Bank to leave rates unchanged at its February meeting. These sentiments were echoed at the March meeting.

Subsequent comments from the Bank have underlined their view that the domestic economy remains strong, although in transition across various sectors. The bank’s various comments have seen markets react strongly and almost completely fully discount the prospect of further rate adjustments.

Australian interest rates

Interest rate outlook

In the absence of further destabilisation in Europe and the potential subsequent flow on effects to the domestic economy, the RBA will more than likely be on hold over the next few months.

There is a possibility that the RBA may reduce the cash rate over the June quarter. This would be the low point in this cycle.

Over the second half of the year, interest rates are expected to be unchanged, with the risk that as the global and domestic economies strengthen, markets may begin to incorporate higher interest rates into the outlook. 

Impact for borrowers and savers

The immediate prospect of further decreases in home lending rates has been put on the backburner.

The combination of significantly higher funding costs and no decrease in the cash rate by the RBA resulted in housing loan rates being increased by about 10 basis points.

The advent of out of cycle adjustment of housing loan rates is a recent development in the market. However, this should be viewed in the context of the continual fine tuning of deposit rates, especially term deposit rates that has been evident over the past several years.

In other words, banks have started to align the timing of repricing the asset and the liability sides of their balance sheets.

Savers have benefitted over recent years as banks have built their domestic deposit books, in the face of higher wholesale funding costs in both the domestic and offshore markets.

This market dynamic will continue into the future as term deposits emerge as a newly attractive investment alternative.

For advice you can trust book a complimentary first appointment with Switzer Financial Planning today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.