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What is the real point of lowering interest rates?

With the last rate cut in July bringing official cash rates to 1% (the lowest level on record), it has also meant that average standard variable home loan rates are also sitting at levels not seen since the 1960’s (when the RBA began recording loan rates).  Couple historically low loan rates with an easing in financial institution credit requirements (which tightened considerably during and post the Royal Banking Commission) and you could be forgiven for thinking that all of these factors were contrived to manipulate the price of housing.

And data certainly supports this idea.  Housing finance figures released earlier this month by the RBA showed the value of housing finance increased 5.1% in July (the biggest one month increase in seasonally adjusted terms since March 2015 – when the RBA cut the cash rate to 2.25%.  Albeit, in August, the value of housing loans was still 14% below where it was 12 months ago. 

However, low loan rates, an increase in housing finance and potentially higher house prices are simply a by-product of reduced interest rates.  The real point of the RBA lowering interest rates is to stimulate economic activity, achieve the inflation target over time (between 2 and 3% – currently sitting around 1.6%) “and support sustainable growth in the economy” according to the minutes of the RBA September meeting – also called Monetary Policy.   

Rate cuts in June and July were specifically aimed at lowering unemployment, however, with recent unemployment data showing unemployment increased to 5.3% in August (0.8% higher than were the RBA needs unemployment to be), another rate cut in October seems highly likely as a direct response to this data. 

Lower cash rates are also aimed at stimulating consumer spending which translates into economic growth – something that has been very weak given stagnant wages growth.  Lower cash rates also drive the Aussie dollar lower which makes businesses more competitive.

But implementing Monetary Policy is simply not enough – cash rates can only drop so far.  The government’s recent tax cuts to millions of households should help (in theory), as well as a brighter outlook for the resources sector and a lower Aussie dollar, but the RBA is imploring the government to boost infrastructure spending, amongst other things, to make Australia more productive.  If all of these factors come together, RBA Governor Philip Lowe is hopeful of a “gentle turning point” in the economy with a modest increase in economic growth.  Alas, there could very well be an extended period of low interest rates in Australia, making that gentle turning point a while away yet. 

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