As widely, almost universally, expected, the RBA again left the official cash rate unchanged at 4.5 per cent at its 6 July meeting.
The events of the past couple of months have led to a significant shift in opinion about the expected course of monetary policy over the balance of 2010 and beyond. Only a few months back, there was still an expectation that, although the RBA had effectively engineered lending rates to be close to normal levels, ongoing solid economic growth combined with stubbornly high inflation readings would lead to further monetary policy tightening of the order of 0.5 per cent before the end of 2010. This would have taken the official cash rate to five per cent per annum.
The view beyond that was, under the weight of mining boom-induced growth rates, the RBA would need to enter into a restrictive phase for monetary policy and move the cash rate toward six per cent during 2011. All this was subject to there being a measure of ongoing stability, if not positive signs, in global markets.
Well, global markets have been anything but stable. Concerns about European debt levels reemerged during May and have generally dominated market thinking, resulting in significant equity market falls. Pledges by the G20 countries to stabilise and then reduce debt levels only served to add to the weak global growth picture with there being a further deterioration in confidence and a further flight to safety. Risk aversion has been the predominant theme in markets and this has produced major downturns in equities and a reticence to buy debt securities, which has again frustrated the ability of banks to borrow to fund lending.
This market instability and the negative flow on effect on confidence mean that the outlook for world growth remains subdued. Even the robust economic performance in China and Asia is generally anticipated to ease. Central banks, including the RBA, will be cautious in the application of monetary policy in such an environment. They will want to ensure interest rates remain accommodative of growth.
So not only did the RBA leave the official cash rate on hold this month but there is a high likelihood that it will continue to leave monetary policy settings steady until there are clear signs that the global economy is regaining some positive growth momentum.
While locally there continues to be talk about our stubbornly high inflation readings and the need to subdue them, there have been domestic indicators that are suggesting that past interest rate increases are having a depressing effect on growth. These include:
These factors also give the RBA reason to hold off on any further interest rate increases in coming months until there is greater surety that the economy is not slowing down.
An interesting feature of the current market is the effect global economic weakness has had on longer-term interest rates across the developed world. The concern about world growth has pushed these longer rates down including Australian government bond and interest rate swap rates – the latter being a major factor in determining fixed-term funding costs for banks and therefore the level of fixed interest rates they offer for home loans.
The differential between fixed rates and variable rates is narrowing due to the cash rate remaining steady while swap rates fall. Since the official cash rate was raised from 4.25 per cent to 4.5 per cent in early May, the five-year swap rate, for example, has fallen from around 5.9 per cent to 5.3 per cent. While this shift has not yet been fully reflected in five-year fixed mortgage rates, these rates are in decline.
With longer-term expectations remaining that once the present difficult global environment passes Australian interest rates will again need to move higher, these lower levels of term interest rates may offer effective protection against future potential rate rises. The reducing differential to borrow fixed is lowering the cost of insurance in uncertain times and borrowers that can be severely affected by large future interest rate increases should seriously consider this option.
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