Further rates cuts could be risky

02_Further rates cuts could be risky

By Marty Silk
(Australian Associated Press)

Cutting rates to boost inflation can be like a “closing down sale” sign in a store window – if it’s up there too long it just stops working.

The Reserve Bank cut interest rates to an all-time low 1.75 per cent last week on back of deflation in the March quarter.

The bank has since downgraded its inflation projections, forecasting consumer prices to rise between one and two per cent until mid-2018 and remain well below its target band of two to three per cent.

There’s a growing consensus among economists the RBA will cut rates again in August to 1.5 per cent.

Low rates are generally good for mortgagees and consumers with credit card debt because they help reduce their interest repayments, and paying less interest should allow people to spend more, increasing demand and pushing up prices.

But CommSec senior economist Savanth Sebastian said Australia’s low inflation isn’t due to weak demand.

Rather it’s because with overseas competitors dropping prices and digital disruption it’s hard for domestic consumer goods retailers and service providers to lift prices.

Mr Sebastian warns the impact of incremental rate cuts from already low levels will be limited.

“I don’t think any central bank in recent history has been able to achieve higher inflation outcomes from low rates,” he told AAP.

“It’s like seeing a sale sign in a store – if it’s there every day you eventually just walk past it. I think low rates being the norm creates that kind of environment in the wider economy.

“There’s no catalyst to spend for households and business.”

Extremely low rates can also burden savers reliant on earning interest on the cash they have in the bank.

Chairman of global investment firm BlackRock Larry Fink provided a good argument about why ongoing low rates can be risky when he wrote about negative interest rates in an April letter to shareholders.

“Consumers saving for retirement need to reduce spending if they are going to reach their retirement income goals and retirees with lower incomes will need to cut consumption as well,” Mr Fink warned.

“A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending.”

Most central banks that have eased monetary policy in the past few months, like the European Central Bank and the Bank of Japan, have in fact seen inflation remain subdued and their currencies strengthen, pinching exporters.

If the RBA board does cut rates to a fresh all-time low of 1.50 per cent at their afternoon tea on August 2, they run the risk that consumers won’t notice, or worse, rein in their spending.


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