RBA Governor shows the folly of fixing interest rates

If you are about to sign on the dotted line for a fixed rate mortgage, Reserve Bank Governor Dr Philip Lowe is very cautiously whispering in your ear “Don’t do it – wait a bit longer”.

While he didn’t actually say that the Reserve Bank was going to cut official interest rates further this year, he certainly gave a nod and a wink that there would need to be extraordinary set of circumstances for that not to happen.

Such as a rapid positive response to the previous two 25 basis point cuts in rates that led up to the Reserve Bank board’s decision to hold them steady at 1% in August.

There are no signs of that at the moment, indeed the signals are all pointing exactly in the opposite direction.

Trade war creating havoc for markets

The US – China trade war is escalating dramatically, causing some serious falls on world share markets.

President Trump first raised the stakes by promising to raise tariffs on China.

China retaliated with a sudden devaluation of the yuan and a ban on some US agricultural imports such as soy beans and corn.

Then President Trump upped the ante by calling the Chinese action “currency manipulation’’ and said it was a “major violation’’ that would “weaken China over time.’’

There are no winners in a trade war

The truth is there are no winners in a trade war and both sides will be weakened unless there is some sort of breakthrough in this escalating trade disputes, which is looking less likely by the day.

Here in Australia the trade troubles led to 10-year Australian Government Bonds trading on a yield below 1%, a sure sign that the market believes official interest rates will head below 1% as well.

The RBA only mentioned the turmoil in world markets in passing but it is clear they are worried about the problems facing the Australian economy – and that was before iron ore slid lower than US$100 a tonne.

Dr Lowe said the outlook remained reasonable but he was concerned that the uncertain environment caused by trade disputes was affecting investment.

RBA forecasts worsening

The RBA downgraded its forecasts for growth and unemployment and the outlook for inflation was not much better, and is only expected to return to the RBA’s 2% to 3% target band in 2021.

As for unemployment, Dr Lowe has made it clear he wants the rate at 4.5% or lower to help raise wages and inflation but the new RBA forecasts If that is not enough of a clue that interest rates could be falling even further, there was one comment that really let the cat out of the bag.

“It is reasonable to expect that an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target,” he said.

Markets know how to read the tealeaves in that statement which is why they now expect the RBA to take official rates down to 0.75% November and follow that up with another cut to 0.5% sometime early in 2020.