The RBA takes a “steady as she goes” approach

First published 05 February 2014, 01:06 PM

As you can see from our chart at the bottom of this email, the RBA has kept the cash rate on hold for another month. This decision has largely been made because the inflation rate is steady.

We are always asked by clients and media representatives to provide interest rate forecasts. This is a dangerous game as the world economy is unpredictable. However, we do believe that a greater understanding of the RBA’s objectives will help us make better interest rate choices.

The RBA’s approach is fairly simple and predictable…..

Low inflation and high unemployment indicate that our economy is weaker. Conversely, high inflation and low unemployment point to an overheated economy. The RBA strives to smooth out the booms and busts to have a steady rate of growth.

If an economy is weak, the RBA reduces interest rates to put more cash in borrower’s pockets. If the economy is overheating the RBA takes money out of our pockets via higher interest rates.

This approach sounds relatively sensible. However, the Aussie Dollar represents a potential “spanner in the works”.

If the exchange rate experts are right, the Aussie dollar is expected to continue on a downward trend. This is largely do to the fact that the USA is going to stop flooding the world market with US dollars. If this happens the cost of imported items will become more expensive. These higher prices will push up the inflation rate. The RBA could then move to quell rising prices (inflation) by raising our variable home loan interest rates.

So, as you can see, if the Aussie dollar does continue its downward trend, there is a good chance that we will see higher variable home loan rates.

With fixed home loan rates at historic lows, this analysis does provide food for thought when it comes to that “fixed vs variable” decision.