Could the RBA cut interest rates to 2%?

The Fed’s decision has increased the likelihood of a further rate cut.

Prior to the US Federal Reserve’s meeting last week, many believed that the Reserve Bank of Australia’s  easing cycle was complete after its decision to cut interest rates to 2.5% in August. However, many are now predicting the RBA board will be forced to cut the cash rate even lower when it meets in November.

Whilst the Australian dollar has remained strong against the US greenback for years, tourism operators and key exporters, such as BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO), have struggled for growth. As such, the RBA has been applying downwards pressure on the Australian dollar by lowering its interest rates.

It had managed to depreciate the Aussie dollar from around US$1.06 earlier in the year to below US90c, however, the dollar has crept back up past the US95c mark following the Fed’s decision to delay the taper of its bond buying program, prompting the need for further action.

That is the view of Macquarie chief executive Brian Redican, who believes that the RBA could drop the cash rate to as low as 2% before it officially finishes its easing cycle.

Whilst the strength of the dollar was certainly reliant on the Fed’s decision to begin tapering, Redican suggested that it was also being affected by strong news out of China. As “the tone of the data out of China has improved over the last six weeks or so” and is expected to continue over the next few months, the dollar is unlikely to find relief from this source.

Despite the notion that the board is finished cutting interest rates, it seems appropriate to think that the RBA may need to consider further cuts to continue pushing the dollar downwards.

Foolish takeaway

When the dollar increased after the Fed’s announcement, companies with heavy exposure to overseas markets, such as Cochlear (ASX: COH) and QBE Insurance (ASX: QBE), fell in value. It would be a risky move to lower interest rates further given the threat of creating a property price bubble, however, whilst there are a number of companies relying on a depreciating dollar, it seems that it would be a necessary move.

In times of heavy economic volatility, it is easy to become unnerved; however, there are still plenty of good long-term prospects. For instance, are you interested in our #1 dividend-paying stock? Discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”

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Motley Fool contributor Ryan Newman owns shares in Cochlear.

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