Tomorrow's interest rate decision could come down to a coin toss.
According to the ASX's RBA Rate Indicator, there's a 49% chance the Reserve Bank's board members will provide the market with further stimulus on Melbourne Cup Day by decreasing the nation's cash rate to a record low 1.75%. They're not strong odds, by any means, but there are certainly some strong arguments in favour of another cut.
Here are five reasons why Glenn Stevens and his fellow board members should cut interest rates when they meet tomorrow:
1. Inflation
Chances of an interest rate cut soared to 67% on Wednesday last week, according to the ASX, following the release of the September quarter inflation figures by the Australian Bureau of Statistics. The data showed that our economy grew just 0.5% during the three-month period and 1.5% for the year.
The underlying inflation rate, which the RBA watches closely, rose just 2.1%, which is at the lower end of the board's target range (2% to 3%). It's also falling at a troubling rate which suggests further stimulatory measures are required sooner rather than later.
2. Interest Rates
All four of Australia's major banks have increased their interest rates to customers as a result of stricter regulations requiring them to hold more capital as a buffer against a potential economic downturn.
Westpac Banking Corp (ASX: WBC) increased its rates by 0.2% while National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Commonwealth Bank of Australia (ASX: CBA) all hiked theirs between 0.15% and 0.18%.
This means more cash outlays for individuals trying to pay off their mortgages which is hardly ideal at a time where business and consumer confidence levels are already low. The Reserve Bank may need to cut the cash rate to counteract this.
3. Retail Dismay
Christmas is typically the most important time for Australia's retailers and the period of the year where they make a large bulk of their sales. We've already seen poor results from companies like Woolworths Limited (ASX: WOW) and Dick Smith Holdings Ltd (ASX: DSH) (which can be read here, and here), both of which are in desperate need of a pick-up in retail conditions over the coming months and could benefit from an official interest rate cut.
4. House prices
The Reserve Bank last cut interest rates in May and has been hesitant to do so again due to soaring house prices. House prices have since come off the boil, providing further flexibility for the Reserve Bank to make its move. Instead of going to the property market, a cut could be more beneficial to business and consumer confidence levels.
5. Commodity prices
The prices of some of Australia's most important commodities have fallen sharply over the last 12 months, with further falls expected over the coming months or years. As these commodities are priced in US dollars however, their price falls are offset somewhat by a weaker Australian dollar.
Lower interest rates should force the dollar even lower, with some economists forecasting a drop to US 65 cents if the RBA does cut rates again (down from US 71 cents today). This would be made even more likely if the US Federal Reserve was to strengthen the US dollar by hiking interest rates at the same time.
Foolish Takeaway
With interest rates already sitting at a record low, the RBA is running out of ammunition. It must be certain that the economy requires further stimulation before it acts, which suggests it may hold off for a little longer before making a move (as highlighted above, it seems they're just as likely to leave rates unchanged tomorrow as they are to cut them to 1.75%).
In saying that, however, there are some very strong arguments for further interest rate cuts, with some economists suggesting there will be two interest rate cuts in the first-half of 2016. One way or another, it's almost certain that interest rates will remain low for the foreseeable future, making it necessary for investors to expose their portfolios to high-yielding dividend stocks to grow their wealth.
