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RBA holding interest rates may make Christmas less merry

The RBA’s decision to keep interest rates on hold this month has sent several different signals to both the international and domestic markets. After the dollar made a bottom at around $0.89 to the US dollar in late August, it has rebounded to about $0.93, up 4.4% on market expectations that the Australian market is making a turnaround and the interest rate cutting cycle may at or near its end.

It has also drawn the attention of domestic retailers who see their revenues flat or lower because of low consumer sentiment. Holding at a cash target rate of 2.5%, the RBA is seeing upward price moves in housing due to the low interest rates, however in its 3 September meeting notes it writes, “There were further signs that wage growth had eased over the year. The wage price index rose by 0.7 per cent in the June quarter to be 2.9 per cent higher over the year, which was around ¾ percentage point below the average over the past decade.”

It believes that this is consistent with the subdued labour market conditions and an elevated concern by households about unemployment.

When interest rates are changed, either up or down, it sometimes takes 6-12 months for the effect to fully work its way through the economy, so at this point the RBA is signalling by its actions that more may need be done to relieve economic pressure, but its concern right now is the possibility of overshooting the target, and causing too much inflationary growth.

This week it was reported that Solomon Lew, chairman of Premier Investments (ASX: PMV), operator of apparel stores such as Just Jeans, Portmans and Jay Jays, would want to see interest rates cut by as much as 0.5% by Christmas season to encourage consumer spending during the biggest retail season of the whole year.

Other retailers like Noni B (ASX: NBL), Specialty Fashion Group (ASX: SFH), as well as department stores Myer (ASX: MYR) and David Jones (ASX: DJS) have all reported flat or falling sales, and without more stimulus, they believe customers will keep their hands in their pockets unless they themselves feel that the economy is truly growing for them.

Foolish takeaway

The RBA’s role is to help manage the economy by applying a brake when it overheats, and accelerate when it takes a turn down. This is all to smooth out the peaks and valleys of the regular business cycle that itself cannot be fully controlled or done away with. Lower interest rates encourage investors to buy more properties, but they are borrowing the money to do so after weighing the cost of debt against potential return.

Consumers are slower acting because they for the most part are using only their income to make day-to-day purchases, aided slightly by credit. They have to feel they are making more and/or their expenses are steady and manageable before they increase their spending.

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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