Reserve Bank Board says current 4.35 percent official interest rate level to persist for now

Minutes of the March Monetary Policy Meeting

The Reserve Bank Board at its March Monetary Policy meeting reiterated that no change to the 4.35 percent official interest rate is necessary anytime soon. The primary reason for no change to the cash rate is that inflation remains high and is only gradually returning to target, and that the labour market remains at or close to the natural rate of full employment.

The RBA inflation rate target is for a return to the range of 2-3 per cent by mid-2025, and to the midpoint of this range in 2026. However, with inflation firmly entrenched at 4.1 percent for the year to December 2023, it may take several successive quarterly inflation readings before the domestic economy reaches this inflation level target range. This outlook reflects the RBA’s observations in March that services price inflation is expected to decline gradually, and employment is expected to continue to grow moderately. Considering these assessments, the RBA felt it was justified and appropriate to leave the cash rate unchanged.

But there is another reason why the RBA is unlikely to cut official interest rates in the near-term, and it has to do with the high level of employment and the impact this is having on wages growth. The clue to this thinking by the present RBA Board goes back to 20 June 2023 when the current RBA Board Chair, Governor Michelle Bullock said that the unemployment rate is expected to rise to 4½ per cent by late 2024 and this rate is below where it was pre-pandemic. Furthermore, Ms Bullock went on to say that 4½ percent unemployment is not far off where the natural Non-accelerating Inflation Rate of Unemployment (NAIRU) might currently be. In other words, at 4½ percent unemployment, the economy would be closer to a sustainable balance point which is, in effect, the RBA’s definition of full employment. This implies that unemployment may need to rise to 4½ percent before the current RBA Board reduces the official cash rate. Unemployment currently sits at 3.8 percent.

Australian interest rates v rest of the world

The RBA Board in March noted that fewer reductions in the official monetary policy rate were expected in Australia than in many other advanced economies. They observed that, in part, this was likely because the Australian cash rate had not risen as high as policy rates in other economies, as the RBA Board had previously chosen to return inflation to target gradually over time to preserve the gains in employment. The RBA further observed that market expectations were for policy rates to be at broadly similar levels by the end of 2025 across many advanced economies, including Australia. This is a clear indication that until the US Federal Reserve reduces its official interest rate, the RBA may be in no rush to reduce its official interest rate here in Australia. The US Federal Reserve Funds rate sits at 5.5 percent. This is at least two notches higher than the RBA official cash interest rate at 4.35 percent.

Australian interest rate cuts not necessary

Another indication that the RBA may not consider that a cut in official interest rates is necessary for now is that the RBA stated in March that while banks expected overall loan arrears to pick up further in the period ahead, they remain low relative to history. Some households were finding it difficult to service their debts and meet essential expenses, however rates of arrears on housing loans were still low and banks had recently reduced their forecasts of potential loan losses. Risks to the financial system from lending to households and businesses remained contained, according to the RBA. This reflected most Australian households’ and businesses’ strong financial starting positions, resilient labour market conditions and sound lending standards in recent years, the RBA said. The RBA went on to say that banks’ high capital levels, profitability and provisions left them well placed to absorb a deterioration in credit quality in the event of worse-than-expected macroeconomic conditions.

Implications for investors

Unless there is a dramatic change to the domestic economy outlook, the RBA’s stated intention is to remain resolute in returning inflation to target by keeping the official interest rate on hold for at least the foreseeable future. This implies that investors should avoid companies which are ‘interest rate dependent’. In other words, investors should seek out well-capitalised, strong cash flow businesses that service markets which are not dependent on easier monetary conditions or lower interest rates to sustain present consumption levels.