What can we expect from the RBA interest decision?

The rate of the United States dollar to the Australian dollar has remained stable since the start of 2015, ranging from 1.2 to 1.4. During that time, Australian interest rates have declined. At its April 2018 meeting, the Australian Reserve Bank (RBA) left its key cash interest rate unchanged at a rate of 1.5% in a move that was largely anticipated by the financial markets.

In its April statement, the RBA recognized that the Australian economy was viewed as strengthening in 2018 over the previous year. The 1.5% level is an historically record low in comparison to the average rate from 1990 to 2018 of 4.6%. The all-time high level of Australian interest rates was reached in 1990 with a level of 17.5%. The key thought on the mind of financial market participants is “where do interest rates go now?” As ever, the answer to this simple question is: “it’s complicated”. Naturally, should its economy start to warm up - and the Australian market, like nearly all of the major global markets, has remained decidedly cool for the past 10 years - then the RBA will undoubtedly raise rates. Two questions remain—when, and by how much?

May 1, 2018, will see the next interest rate announcement by the RBA when the Board announces its key interest rate for the next five weeks. The previous rate was 1.5%, and in all likelihood the next announcement will also be 1.5%. Not too much to set the markets alight there. Should the rate remain unchanged, as it has since mid-2016, then the impact on the Australian dollar will be minimal. However, should any change in the key interest rate occur, then the currency will certainly be affected. A rise in the key rate will be seen by the markets as a sign that the Central Bank is seeking to dampen down any inflationary pressure by making the cost of borrowing money more expensive. Any increase will inevitably be small, probably no more than 0.25%, but this would see international traders start to buy the Australian dollar against other currencies. Conversely, any reduction in the key interest rate will be met with traders and investors selling off the Australian currency.

While any move in the RBA interest rate will be small, this must always be viewed in a large context of watching for the trend of future interest rate and currency movements. The US economy has been improving for the past six to eight months, and reflecting that, the US Federal Reserve has begun to edge up interest rates. This inevitably results in increasing differentials between the interest offered on US currency assets, compared to those offered by other leading financial nations. Essentially, it’s all about the economy, with economic growth being measured by a whole host of statistics. Key among those are industrial growth and output, employment rates, and the rise in domestic factors such as house-price inflation. If an economy is growing well, with increasing GDP figures, steady employment rates, and firm to rising house prices, then a central bank will inevitably want to keep the lid on inflationary pressure by raising its interest rates. This interest rate tweaking is the key measure of control that will keep an economy on track. The last thing any central bank wants to see is inflation starting to outpace economic growth, which will negatively impact any healthy economic developments. Key to that economic growth is the establishment of a strong currency, but too strong a currency will mean that exports can become too expensive. As mentioned above, it’s complicated.

As with all trends in the financial markets, no one central bank can tell when one trend ends and another will begin. If they could, then that country need never again experience any financial woes. The financial market adage goes: “the trend is your friend”, and that applies to central banks as much as it does for floor traders. Currently, the RBA is keeping rates steady, and that essentially is the trend that has existed for the past 20 months. Any change in interest rates may be a subtle adjustment, possibly for the sake of appearances, but a rise or fall in rates for two to three months signifies that a new trend is developing, and investors will sit up and take notice.

For the time being, financial analysis suggest that the RBA will keep rates steady at their current 1.5%, continuing its record breaking run of low credit availability. The current unemployment rate of 5.5% is an added factor. This exceeds the RBA’s own sub-5% level, suggesting that wage inflation is not something that will occur any time soon, certainly within the next three to six months. And, despite the warming US economy, similar signs of growing economic activity have yet to be seen in the Australian market. The RBA’s own growth target for economic growth has been set to 3.25% for 2018 and 2019, which does seem optimistic. Should growth figures fall below those targets, then interest rates are destined to remain at their current historically low levels.
In spite of this outlook for further sluggish growth, attention should be paid to statements made by the RBA regarding wage inflation. The Governor of the RBA recently stated that “the rate of wage growth appears to have troughed”. This is a change from statements made at previous meetings of the Board and could signal a future rise in wage growth from the 2% level of September 2018 to a level of 2.1% for December 2018. Such a move is likely to be taken as a positive sign that the economy may indeed have bottomed out.

As the markets sit and wait for the development of new market trends and direction, the most likely outcome is that Australian interest and currency rates will remain unchanged for the next three to six months, with a positive change of track expected in Q3 to Q4 2018.