The Reserve Bank of Australia doesn’t cut interest rates when economic times are good

10 May 2016

Earlier this month, the Reserve Bank of Australia (RBA) cut the official cash rate to 1.75%, its lowest level in history. Just what does this mean for your business? One key takeaway is that a central bank does not cut interest rates when the economic outlook is rosy. Interest rates are cut when central banks believe an economy needs a helping hand in lifting momentum in order to grow spending enough to escape its present sluggish state.

Unusually in Australia’s current economic environment, it is a case of very low inflation, and not slow real growth, that is worrying the RBA. The RBA forecasts that overall prices in the economy will grow just 1% y/y by mid-2016 and only pick up to around 1.5% by the end of the year. This is considerably slower than the RBA’s official target of 2-3% over the cycle.

With the economy in real (ex-inflation) terms expected to maintain a relatively consistent 3% y/y pace of growth this year, this means that the broad nominal growth in your business (and invoices) can be roughly expected to trend around 4-4.5% - versus the average of 5% p.a. over the past 5 years. With a relatively slower pace of potential growth for your cash flow, this makes cash flow management even more important for every business - do you know where you stand with your debtors and creditors? How will your bank balance look in three months’ time?

Is there any good news hidden in the doom and gloom? One glimmer of good news is that with inflation quite low, overall business running costs should remain relatively steady overall and wage growth is expected to remain subdued.

The response of the Australian dollar, as always, is a mixed blessing for businesses. Exporters will appreciate the helping hand provided by the Aussie dollar now worth around 73 US cents (a 6.4% fall from the 78 cent level that it was trading at only a few weeks ago), which makes their goods more competitive on the global market. But those businesses more reliant upon imported inputs for their line of work will find that they will need to stretch every dollar even further as the weaker currency makes imports more expensive.

Good luck out there,

The Debtze Economist

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