Error
  • JUser: :_load: Unable to load user with ID: 565
Wednesday, 08 May 2013 13:32

How low can interest rates go?

Written by 
Rate this item
(0 votes)

Interest Rate ImageWe expect the Reserve Bank will complement its May rate cut of 0.25% with a follow up move of 0.25% in June. Rates are expected to eventually
bottom out at 2% by the first quarter of 2014 (that is 0.75% lower than today).

There are ample precedents for a May/June move. Over the last 10 years the Bank has moved rates on four occasions in May with two of those occasions being followed up in June.

The really key new developments over the last few weeks have been evidence
of an even lower than expected trajectory for inflation and, as pointed out
in this note, a Reserve Bank that is clearly open to further action.

Given this scenario we think that the most likely policy option is a follow
up rate cut in June of 0.25% which will be implemented for the same reasons
as we have seen today complemented by further evidence of softening
confidence and weak business investment.

We have also always argued that our assessment of the global economy is
more subdued than the consensus. The IMF is expecting 4% world growth in
2014 – we are closer to 3%. For Australia's terms of trade, the peak to
trough decline in the 2011–12 period was 17%, while we forecast a 2013–14
decline in the region of 10%. We have long maintained that from a world
growth perspective, 2014 will feel like 2012.

The threat of a disruptive event in Europe remains ever present.

The US story does not convince us. We confidently expect that the US
Federal Reserve will persist with its quantitative easing policy through
most of 2014.

China has already begun the process of recalibrating its monetary and real
estate policy settings and the support it received from the export sector
in Q1 is already receding. Indian domestic demand is flagging badly and the
required policy support has not been adequate. Japan is something of a
bright spot, but its gross acceleration will far exceed the net from a
global growth perspective as it takes back market share.

From June we expect the Bank will be patient to assess the impact on
domestic demand of the low rates. However by year's end it will become
clear that further stimulus will be required to offset the impact of a
softening world economy while the response to the low rates in the domestic
economy will be disappointing.

We anticipate two further rate cuts will be required in the December
quarter of this year and March quarter of next year. That would see the
cash rate bottom out at 2% from its current 2.75%. Having driven rates down
to that level we expect rates to remain on hold through the remainder of
2014.

Our specific profile for the Australian dollar, which had incorporated a
steady cash rate of 2.75% (with downside risks) and a softening world
economy, saw AUD back at USD 0.97 by June next year, partially due to a
gradual narrowing of the overvaluation premium.

With our lower RBA rate profile there is some modest room for further
moderation in the fair value of AUD with our June 2014 target being lowered
to USD 0.96. However, the key to a more significant fall in AUD is a more
marked reduction in that over valuation premium – something that lies
essentially outside the RBA's influence.

 

Bill Evans - Chief Economist - Westpac Banking Corporation

 

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

 

Read 1195 times Last modified on Wednesday, 08 May 2013 13:32
Login to post comments