By Michael Witts

What were the reasons behind yesterday's rate decision? What were the main points in yesterday’s statement?

At the meeting yesterday the RBA, somewhat surprisingly, cut the cash rate to 2.25%. The RBA now believes that output growth will probably remain a little below trend for somewhat longer and the rate of unemployment will peak a little higher than earlier expected.  Equally, domestic demand growth overall is now seen to be quite weak.

The RBA appears to have changed their forecasts for the economy over the medium term. Again, this appears to be a significant change from the final months of 2014.

What is the outlook for the cash rate in 2015? Should we expect another rate cut next month?

In contrast to previous months the RBA has provided no guidance in terms of the likely future direction of interest rates. The decision yesterday would appear to have been line ball and more directed at achieving a lower exchange rate. The RBA noted that the exchange rate remains above fundamental value in light of commodity price falls and a still lower exchange rate is required to achieve balanced growth in the economy.

It is somewhat challenging to agree with the case for further interest rate reductions, as the main economic indicators for Australia remain positive. Indeed, the RBA noted that the housing market is an area of concern for the RBA and the Australian Prudential Regulation Authority (APRA). This suggests that there will be more qualitative measures from APRA in relation to lending to the investor market.

The closest the RBA came yesterday to indicating that further rate cuts could be a prospect was saying that the economy appears to be operating with a degree of spare capacity, and this is likely to continue for some time yet.

The market currently supports the view that further rate cuts are likely in the period ahead, although, as has been seen in the past few months, expectations can turn around very quickly.

What is the RBA’s view on the Australian economy and the global economy?

The RBA appears to have increased their concerns about the prospect for global and domestic growth over the summer holidays, however they have not pointed to any stand-out events that have driven this change in viewpoint.

The global economy is viewed as likely to experience moderate growth led by the US economy, although this will be offset by weaker European and Japanese growth, while domestic growth is forecast by the RBA to be a little below trend for somewhat longer than previously expected.

Indeed over this period most domestic indicators have surprised to the top side. This serves to reinforce the view that the cut in the cash rate yesterday was driven by dual considerations, namely their modeled economic forecasts and a desire to drive the currency lower. The RBA noted that the Australian dollar, although significantly lower against the US dollar, is less weak than against a basket of currencies. This does not appear consistent with the trade weighted index (TWI) value of the Australian dollar, which was at 63.90 prior to yesterday’s RBA announcement.  At this level the TWI is at the lowest it has been since the depth of the GFC at the end of 2008.

What are the main concerns for the RBA this year?

The Bank remains focused on the impact the exchange rate has had and can have in the transition of the economy. In the RBA’s ideal world the exchange rate would be lower, reflecting the decrease in the terms of trade, however this relationship has not worked as effectively as in the past. Through the lower interest rates, the RBA is trying to achieve a lower exchange rate.

The historically strong relationship between the terms of trade and the exchange rate has been weakened by the growth of the Australian dollar as a reserve currency, where the holdings are less driven by exchange rates. Equally, the shrinking universe of AAA rating countries is further contributing to the relative strength of the Australian dollar.

What is ING DIRECT’s outlook for the Australian economy and the Aussie dollar this year?

We were surprised at the RBA decision. It appears that the RBA has a more negative view of the economy than many observers. In 2016 there will be strong export growth due in particular to LNG exports coming on stream.

Therefore, we will be paying close attention to economic data and RBA comments over the next few months.