By Michael Witts

What were the reasons behind yesterday's rate decision?

In yesterday’s decision the RBA appears to be focussed upon stimulating business investment and achieving a lower exchange rate. They seemingly looked through the strength of the housing market, particularly in Sydney, in delivering a further cut. Instead the RBA continues to look towards other regulators to step up and contribute towards a slowdown in housing price inflation.

The Board appears to be signally that this could be the final move on rates for a period of time, given they deleted the reference to scope for further adjustments to the cash rate.

Indeed, subsequent to the statement from the RBA, both the exchange rate and interest rates moved sharply higher; the Australian dollar to above 79 cents and interest rate swaps rates increased by about 10 basis points. In the event this increase in swap rates is sustained, this will likely feed directly into fixed rate mortgage pricing over the next couple of weeks.

Did the RBA make the right or wrong decision yesterday? Why? Should we expect more rate cuts or increases?

It is interesting to consider what the RBA was trying to achieve out of yesterday’s decision. Clearly they were looking to coax the currency lower, however the direct opposite has happened. By signally that there is a reasonable likelihood that this is the last move, the market has pushed the yield curve sharply steeper, which may weaken the potentially positive impact on business investment. 

When businesses contemplate investment decisions it is not so much short term rates that are important, rather longer term rates are relevant. In this context, the increase in swaps rates may lessen the impact the RBA was expecting.

The market response was perhaps inevitable, given that the RBA has potentially indicated that the interest rate party is coming to an end.

Is the RBA worried about the property sector, especially in Sydney?

Yes they are, but perhaps less so than most commentators have perceived. The Bank is looking for the actions of other regulators i.e. APRA, to become more meaningful and effective.

It will be interesting to see if APRA is more vocal in their comments over the next few weeks.

Is the RBA happy with the level of the Australian dollar?

In a word no.

Through the cut yesterday they are looking for the Australian dollar to move lower against both the US dollar and on a trade-weighted basis, therefore they would be disappointed by the initial response from the market. There is the potential for the RBA to take measures over the short term to encourage the currency lower. 

What is the RBA most concerned about at the moment?

The dual issues for the bank are the lack of recovery in business investment and the level of the currency.

The bank is happy with the recovery in household spending, however they will be concerned with the market response in terms of the shape of the yield curve and the absolute increase in rates, and the potential flow on effect to business and household attitudes to incurring debt.

What is ING Direct’s view on the economy and the Australian dollar?

The effectiveness of still lower interest rates has been seriously questioned over recent quarters. Therefore, the key to the economy going forward will be the impact of the Budget on the broader economy.

The role of solid investment and infrastructure spending are the important elements for the economy going forward.

The Australian dollar has proved strongly resilient in the face of lower interest rates, therefore it seems likely that the link with commodity prices, and terms of trade, has weakened, however, the RBA appears convinced that in the long run this relationship will be re-established with the same strength as previously. Time will be the final arbitrator in this debate.

We would be surprised if there were further rate cuts in the near to medium term and are not necessarily convinced the Australian dollar will move lower until the US Fed starts to normalise US interest rates.