The RBA’s decision last week to lower the official cash rate, by 0.25% to 3.25%, begs the question of just how low can rates go. At the current level, they are approaching the low of 3.00% seen around the time of the GFC, as well as the all time low seen in January 1960, when the benchmark sat at 2.89%! Interestingly, markets are anticipating a series of further cuts, pricing in a fall in rates to a low of 2.75% by February 2013.
Rate decisions by the RBA in recent years have rested on two key issues – the outlook for employment, and the outlook for commodity prices. These two issues featured prominently in the RBA’s discussion of its most recent decision, and what is interesting is the change in thought on each.
While the total level of employment remains robust, unemployment is officially at 5.1%, there is no doubt that softness is beginning to emerge. This is particularly the case when one considers the lack of full time positions that have been created over the last 12 months, as well as the drop in the labour participation rate. This softness is also linked to the weakness that we are now seeing in parts of the mining sector.
Secondly, there are genuine concerns over the strength of the Chinese economy, as it transitions away from capital investment to consumption led growth. This is highlighted by the significant weakness in iron ore and coal prices over the last 4 months. The knock on effect of this has been to see the deferral of a number of mining related projects in Australia. This is a concern, as the RBA has often pointed to the strong pipeline of mining projects as providing a buffer for the Australian economy. At the same time, the Australian dollar has failed to adjust to this lower level of commodity prices, as global investors continue to invest in higher yielding Australian assets. The high dollar hampers the competitiveness of local industry.
The case for lower rates for longer is strong. Just where rates settle will depend very much on the outlook for China, which should become clearer over the next 3 months, with the transition to a new leadership, and to new avenues of growth.