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RBA cuts interest rates to 2.25%: Here’s what you need to know

RBA Reserve Bank

The Reserve Bank of Australia surprised the market with an interest rate cut today, slashing the official cash rate by 25 basis points to a record low of 2.25%.

While the central bank has not tampered with interest rates since August 2013, the board said that local growth is continuing at a below-trend pace while growth in domestic demand was also quite weak. This has also resulted in a higher unemployment rate which is currently sitting at a seasonally adjusted 6.1%.

Although the heavy decline in oil prices over the last seven months should provide a boost to consumer spending, a decline in the terms of trade would act to reduce income growth.

While it saw little chance of the inflation rate rising above target over the next one or two years, the board said: “Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.”

The Australian Dollar

In addition, the RBA has been targeting a lower Australian dollar for some time now. While the Australian dollar (AUD) has declined heavily against the US greenback in recent months, it remains historically strong against a ‘basket of other currencies’.

The AUD plunged more than 1.8% after the announcement to just 76.54 US cents – its lowest level in more than five years. The UK pound is also moving closer to buying two Australian dollars – a level not seen for many years, currently the AUD/GBP rate is 1.962.

That’s great news for Australian companies which generate most of their earnings overseas, including ResMed Inc. (CHESS) (ASX: RMD) and Amcor Limited (ASX: AMC).

It’s also great news for Australia’s miners which are already struggling against the commodities crisis. Had the RBA chosen to keep interest rates on “hold”, the dollar may have strengthened which would have exacerbated the commodity rout facing the nation.

Dividends

High-yield dividend stocks will also be amongst the biggest winners from today’s announcement. With lower interest rates, investors will increasingly turn their back on the ‘safety’ of term deposits to take advantage of the solid dividends paid by some of Australia’s largest and most reliable companies.

Telstra Corporation Ltd (ASX: TLS), for instance, jumped 1.5% while Commonwealth Bank of Australia (ASX: CBA) rose 0.4% to a fresh all-time high at $90.10. Meanwhile, Australia and New Zealand Banking Group (ASX: ANZ), Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB) all rose between 0.9% and 1.7%.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned. You can follow Ryan on Twitter @ASXvalueinvest.

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