Why today's RBA cut had the opposite effect you'd expect

Earlier today the RBA cut its official cash rate to 2%, an all-time record low.

While it was largely expected by the markets – 85% of economists expected a cut while cash rate futures put the probability at close to 75% prior to the RBA announcement – usually a reduction to the cash rate would also lower the Australian Dollar.

But not today.

In some ways it shows the unique times we live in.

No longer is a rate cut sufficient to lower a currency. Forward guidance – an increasingly-common phrase in recent years – is now as important, if not more so, than an actual rate movement. It essentially guides perceptions as to what direction rates are likely to head next. When it changes it can cause large and somewhat curious market movements, which is what we’ve seen today.

Let’s have a look at the forward guidance the RBA offered in its April monetary statement.

“At today’s meeting the Board judged that it was appropriate to hold interest rates steady for the time being. Further easing of policy may be appropriate over the period ahead, in order to foster sustainable growth in demand and inflation consistent with the target. The Board will continue to assess the case for such action at forthcoming meetings”.

Now, let’s look at the forward guidance offered today following its decision to lower interest rates.

“At today’s meeting, the Board judged that the inflation outlook provided the opportunity for monetary policy to be eased further, so as to reinforce recent encouraging trends in household demand“.

Obviously, having indicated that rates could be lowered further in April, they now indicate that they’re likely to remain steady.

It may seem like semantics but, in a world of where investors are chasing any yield, even negative yields, a hint that rates will remain steady – or even move higher – will attract investment flows.

That’s what the RBA have done today. They have told the global investment world that instead of cutting rates further they are now done – at least for the foreseeable future.

On the Australian Dollar the RBA had this to say today: “further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices”.

Given rates appear now on hold, with the removal of the statement that “further easing … may be appropriate”, the “necessary” depreciation looks like it’ll come from somewhere else.

Step forward, the US Federal Reserve.

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