Where To Now, For Interest Rates?

Key Components are distorting the CPITHE RBA Board’s big 0.5% cut in the cash rate surprised many people. While others were wondering … what took them so long?

You could certainly be forgiven for thinking that the trigger for this latest cut lay in the underlying inflation (at 2.2% pa) now being “under control”.

And also, that the RBA was seeking to lower the Australian dollar to assist manufacturers and exporters.

Clearly, the RBA’s motive was to inject some much-needed confidence into the economy — which would not have been achieved by making two 0.25% cuts, a month apart.

Besides, doing that could have been misconstrued as an endorsement for Wayne Swan’s budget.

Removing the Confusion

Take a moment to look more closely at the table above.

As you can see, the much-praised underlying inflation rate of 2.2% pa actually distorts the true situation — because the high Australian dollar is encouraging the importing of a significant volume of goods & services.

That serves to keep our underlying inflation rate artificially low — thereby masking the rapid cost increases in wages and the local goods & services.

The Economy will dictate the next Interest Rate moveThis next set of graphs may also help to clarify things further.

According to HSBC’s Paul Blaxham, business conditions are on the improve along with general confidence.

Plus, there are overall signs of improved employment levels — with even some stability emerging within the manufacturing sector.

And despite all their recent huffing and puffing, according to Deloitte Access Economics, the miners have $415.4 billion in projects under construction.

This is 43% up on 12 months ago; with the ABS suggesting that “will rise another 30 per cent in 2012-13.”

The RBA’s Looming Dilemma

The March CPI was low, partly because fruit and vegetable prices fell. But mainly, because the high dollar is deflating the prices of imports like ours, computers and clothing.

Therefore, the equation becomes fairly simple.

If the RBA were to dramatically reduce the cash rate further (as many pundits are calling for) … the Australian dollar would fall — as it would be less attractive to overseas money markets.

Then, on top of rising wages and prices for local goods & services … our prices for imported items would also start increasing.

And taken together, this would return Australia’s underlying inflation to a worrying level once more.

Bottom Line: Hopefully, the RBA’s 0.5% cut will provide the required injection of confidence for the general public to start spending again. Because, fundamentally, that is all Australia really needs right now.

If not, the RBA finds itself in quite a dilemma; and will be most reluctant to lower the cash rate any further.

However, as an investor in Commercial property, you ought take heart: Business confidence is improving, and interest rates are unlikely to fall dramatically. Making it a good time to lock in a fixed-rate mortgage

But more importantly, there are some good purchase opportunities out there, for the astute buyer.

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