In Plain English: Here's why the RBA cut rates yesterday

Photo: Getty Images

The RBA cut rates yesterday for the first time in 18 months to a modern-day low of 2.25%.

The reasons behind the move are complex and have as much to do with the actions of other central banks and what is going on in global markets as they do for what is happening here at home.

But in the 558 words in the Governor’s Statement, there is one theme that sticks out – growth

RBA Governor’s Statement Feb 2015 Wordle Cloud

Shoring up growth is of course the job of the RBA, but given that even many in the economics community didn’t think the case was made for a cut, here’s the plain English version of the Governor’s Statement yesterday. (Plain English in bold.)

Growth in the global economy continued at a moderate pace in 2014. China’s growth was in line with policymakers’ objectives. The US economy continued to strengthen, but the euro area and Japanese economies were both weaker than expected. Forecasts for global growth in 2015 envisage continued moderate growth.

Global growth is weak, China hit its targets for growth but it’s slowing and anywhere else you look – except maybe the US – things are looking weak.

Commodity prices have continued to decline, in some cases sharply. The price of oil in particular has fallen significantly over the past few months. These trends appear to reflect a combination of lower growth in demand and, more importantly, significant increases in supply. The much lower levels of energy prices will act to strengthen global output and temporarily to lower CPI inflation rates.

Our commodities are still tanking and the crash in oil has dragged coal down with it. That means our terms of trade is under pressure – AGAIN – but at least we won’t have an inflation problem.

Financial conditions are very accommodative globally, with long-term borrowing rates for several major sovereigns reaching new all-time lows over recent months. Some risk spreads have widened a little but overall financing costs for creditworthy borrowers remain remarkably low.

Everyone else in central bank land has rates really low and bonds are rallying. That means our rates are too high and might attract capital to the Aussie dollar.

In Australia, the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.

We’re still missing ‘animal spirits’ in business and with unemployment rising and people worried about their jobs, consumers are worried and not spending. But fuel prices are low, so get out there and spend – PLEASE. The crash in commodity prices means the nation isn’t earning as much, however, and growth is weaker than what we are used to with a lot of slack in production and jobs.

The CPI recorded the lowest increase for several years in 2014. This was affected by the sharp decline in oil prices at the end of the year and the removal of the price on carbon. Measures of underlying inflation also declined a little, to around 2ΒΌ per cent over the year. With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate.

Wage growth is really low, which is a bit of a worry. But at least it means we won’t have an inflation problem if we cut, even if the Aussie dollar crashes – as we hope it might.

Credit growth picked up to moderate rates in 2014, with stronger growth in lending to investors in housing assets. Dwelling prices have continued to rise strongly in Sydney, though trends have been more varied in a number of other cities over recent months. The Bank is working with other regulators to assess and contain economic risks that may arise from the housing market.

Right, listen up investors, or should we say bankers, don’t leverage yourselves and your clients up into investment properties or APRA will be coming for you. This means we can ease without worrying about a housing bubble.

The Australian dollar has declined noticeably against a rising US dollar over recent months, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy.

We are sick of everyone else driving their currencies down and the Aussie staying higher than it should be. It’s the economy’s natural shock absorber and we want it lower. If we don’t get it lower, we’ll be back.

For the past year and a half, the cash rate has been stable, as the Board has taken time to assess the effects of the substantial easing in policy that had already been put in place and monitored developments in Australia and abroad. At today’s meeting, taking into account the flow of recent information and updated forecasts, the Board judged that, on balance, a further reduction in the cash rate was appropriate. This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target.

We’ve done nothing for ages. But now we think growth and inflation looks weaker than we thought, so the economy needs the helping hand of lower rates and a falling Aussie dollar. Now please spend, not save the extra cash.

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.