Finance Finance News Yes, the RBA cuts rates again. But will it help?

Yes, the RBA cuts rates again. But will it help?

why the RBA won't do much at all
Will cheap money boost consumer spending on things such as cars? Photo: Getty
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“RBA rate cuts are like Mormons – they come around in pairs.”

I think that line originally came from veteran economist Dr Don Stammer. Whoever thought of it, we’ve had our pair for now. The Reserve Bank has told us it will go back to sitting pat for a while to see what happens next.

Until last month, the RBA had been waiting to see what happens next for nearly three years – the cash rate was reduced to 1.5 per cent in August 2016. The great uncertainty now is whether cutting the rate to just 1 per cent will actually achieve much.

There are several ways of looking at the impact of lower interest rates and some debate about their effectiveness at such low levels.

A quick example of fun with numbers: I can tell you that with rates so low, shaving another quarter or half a perc ent really doesn’t matter much – or I can tell you that the cash rate has been slashed by a third, by far the biggest percentage fall ever in two months, and therefore the percentage reductions that should flow to borrowers will be considerable.

Both ways of looking at it are legitimate, but it’s where textbook economics meets behavioural economics that the outcome becomes tricky.

Firstly, one of the main impacts of these lower rates has been in place all year. According to the textbooks, a key effect of lowering interest rates is to weaken our dollar, thus making our exports more attractive and imports less attractive, stimulating local production.

But the Aussie started the year at US70 cents and that’s what it is now. Oh, it’s bounced around by a cent or so either side of that, but it’s basically gone nowhere, met no one and done nothing much. The market had already priced in these rate cuts.

It happens that our key exports are going very nicely anyway, especially with the windfall gains for iron ore coming from reduced Brazilian production.

Where the textbook and reality part ways though is that the multibillion-dollar super-profits for BHP, Rio, Fortescue and Gina Rinehart aren’t trickling down the way they used to.

Subcontractors are still being squeezed, workers aren’t getting increases in their take-home pay that keep up with (low) inflation. The federal government is getting a tax bonus, but it has dedicated that to producing a surplus bunny out of its political hat.

Aside from the currency impact, the other key contribution from cutting rates is that borrowers’ costs fall, leaving them with more cash in their pockets to spend.

That’s the textbook. Behavioural economics says in times of uncertainty, after years of take-home pay going backwards and when they are already carrying big debts, people have a tendency to try to save instead of spend, to pay down their loans rather than splurge.

That tendency was evident in the last national accounts when our savings ratio ticked up despite the lack of real wages growth. Most people just keep paying down their mortgages at the same monthly repayment rate despite a lower interest rate.

Thirdly, cheaper money is supposed to encourage people to borrow more and take greater risks. Yes, up to a point … but then you run into that already-high household debt problem and businesses that are risk-averse.

And fourthly, it is becoming harder for banks to pass on the RBA cuts in full anyway.

That was on display a month ago when the ANZ copped stick for not passing on the full 25 points.

While everyone reported that NAB cut rates by the full 25 points, what was forgotten was that NAB increased rates by 12 points at the beginning of the year. And NAB has announced it will only trim rates by 19 points this time. Thus, while the cash rate has been cut 50 points so far this year, NAB mortgage holders’ rates have only by 32 points.

The flipside of cutting rates for borrowers is that banks have to cut rates for depositors – and there is a point where deposit rates are too miserably low to attract much money.

Very low rates eat into banks’ profitability and, despite all the bank bashing, we need nicely profitable banks.

That and the matter of Australians already suffering hefty household debt levels were canvassed by the head of the Bank of International Settlements on Sunday. He echoed the many efforts the RBA’s Philip Lowe has made in trying to get the federal government to not just rely on interest rates to stimulate the economy.

Dr Lowe has been doing that for nearly five years with little to show for it.

Cheaper money, cutting rates does promote economic activity, but the jury is out on how much and how quickly.

So Dr Lowe and his fellow RBA colleagues will sit back and watch to see what the lower cash rate might achieve over the next few months.

And hope.

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