STOP PRESS: Today's RBA rate cut is only the sideshow.

It's momentous but we all expected a record cut to interest rates today. And there are 3 other parts of the RBA announcement to consider.

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I hope you'll excuse a second message from me, today. 

I didn't expect to be writing to you this afternoon.

We all expected the Reserve Bank of Australia (RBA) to cut. And it did.

That wasn't going to be remarkable enough to see me put (virtual) pen to paper.

But there was more… so here we are. Let me explain:


The RBA did as expected today, cutting the 'official cash rate' by 0.15 percentage points to (yet another) record low, this time 0.1%.

Yes, this is the last stop before zero. And, if needed, the next step toward negative rates.

As momentous as the change is, it's probably the fourth most important part of today's announcement.

Huh?

Yes, if you have a mortgage, this reduction matters (though the dollars are relatively small, even if they're welcome).

And yes, if you're a saver, you're in more trouble than Speed Gordon.

And yes, the new record is notable, especially with any sort of historical lens, and more so if you remember (or had a mortgage at) a time when borrowers were paying up to 17% in the early 1990s.

But, as I said, it's probably not even on the podium for outcomes, today.

Let's take a look at the three parts of today's RBA announcement that should put the cut to the cash rate in the shade.

1. Quantitative easing 

It's been talked about for ages. The RBA originally didn't want to do it. Then they dipped their toes in the water.

But today's announcement commits the RBA to buying $100 billion worth of Australian government bonds in an effort to keep medium-term interest rates down. The 'official cash rate' affects short term interest rates (and therefore, indirectly, the variable rates we pay on our mortgages), but it doesn't do much for longer term rates, which tend to be at the mercy of the market.

The RBA is putting a very large size 13 boot on medium term interest rates by committing to buy a huge amount of government bonds. And – quick primer – if the RBA is buying, adding to demand, that pushes bond prices up and, as a result, bond yields (a proxy for interest rates) down.

The dollars are huge. And there could be more to come.

2. It used to be the future that mattered. Not any more

In the past, the RBA would adjust settings on the basis that changes took maybe 6-9 months to flow through the economy. If things were starting to heat up, the RBA would act now, knowing that it needed to be ahead of the curve. If things were starting to slow, it would add some stimulus, giving it time to work.

It was the proverbial 'pinch of prevention' being better than a 'pound of cure'.

That's no longer the case.

In the RBA's own words:

…the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. Given the outlook, the Board is not expecting to increase the cash rate for at least three years.

That word – 'actual' – doesn't seem like a big deal, but it is a meaningful change to how it sees its role, and means that even if the RBA expects the inflation rate to be in that range at some point in future, it is committing itself to only act after those inflation numbers come to pass.

That's big.

And, of course, giving a concrete forecast – "… at least three years…" isn't a commitment, but it's close enough, and the market is going to treat it as a quasi-promise, unless and until the RBA tells it otherwise.

3. There may well be more to come

0.1% feels like almost zero, right? So how much more could the RBA do?

Well, we know, at least in part. Quantitative easing and a quasi-promise not to raise rates is part of the 'more' story. But it's far from all of it.

How do we know? Because the bank told us. Immediately after the section I quoted above, the Governor's statement says:

"The Board will keep the size of the bond purchase program under review, particularly in light of the evolving outlook for jobs and inflation."

But wait. The very last sentence of the statement is the kicker – and a real statement of intent:

"The Board is prepared to do more if necessary."

And that was after, earlier in the statement, Governor Lowe had used the P-word once more:

"The Bank remains prepared to purchase bonds in whatever quantity is required to achieve the 3-year yield target."

That is the proverbial bazooka, being primed and made ready. And letting the bad guys know we've got it and aren't afraid of using it.

Yes, the cash rate will get the headlines.

Yes, we should all be paying less for our mortgage as a result (if not, ring around and get a better rate!)

But that's not even close to the main story.

This is the statement of a central bank that is throwing the kitchen sink at the recovery.

At best, it's just what the doctor ordered, in the right amount at the right time.

At worst, it's an enormous overdose of stimulus, leaving the economy (and the bank's balance sheet) exposed unnecessarily.

And, somewhere in between, it'll have a welter of unwanted side effects that are hopefully less severe than the malady itself.

The RBA is hoping to see a lower dollar, which should be good for our exporters, if it comes to pass.

Businesses should be able to borrow more cheaply, hopefully freeing up some cash flow, and helping some very marginal enterprises survive. It should make it cheaper to borrow money to improve, upgrade or enlarge premises, machinery, tools and equipment.

For savers, cash is almost poison, given you'll be going backwards after inflation and bank fees.

For term deposit holders, the future is going to look worse than the present, which already looks worse than the past.

For investors in shares and property, lower interest rates should push up prices. Which is fine… until rates go the other way, so don't celebrate too hard.

But not being invested would be worse. Potentially much worse, over the long run, as asset prices increase, putting those assets further out of reach for some, including poor would-be first home buyers who will see cheaper interest rates, but higher prices and even higher deposits required.

To be sure, these are strange and unusual times. There is still a long way to go.

We have to hope policy-makers, legislators and regulators have made the right calls.

For mine, APRA needs to ensure we don't have reckless borrowing, and that house prices don't end up in a bubble. The same might be said of borrowing to invest on margin. 

We need to make sure first home buyers aren't locked out of the property market, and self-funded retirees don't get lost in the race to zero. The new poor might well be people with cash, but who have to spend more and more of their capital to survive, hastening their move onto the aged pension.

Lastly, as an investment advice business, let me return to investing.

I won't be doing too much differently, if anything at all. But that's because I tend to be fully invested, almost entirely in high quality businesses whose futures are hopefully not dependent on the next – or subsequent – move in interest rates.

I'll be careful of low-growth stocks whose price-to-earnings (P/E) ratios get bid up because of low rates, but who'll surely come back down the other way, in time, because the E (for earnings) won't grow fast enough to offset the return path of the pendulum when rates go up.

I'll keep an eye on companies with too much debt. Not now, so much – it's never been cheaper to be leveraged to the eyeballs – but later, when costs rise and especially if economic conditions become (more) challenging. We've seen Sydney Airport's struggles with lots of debt and not much revenue – that gets worse for indebted businesses when interest rates eventually start rising. Lower quality businesses are even more susceptible.

So, sure, if you have a mortgage, feel free to be a little happier this afternoon as rates fall. If you're a saver, I empathise with your plight as you face a falling income.

But, as an investor, make sure you continue to invest judiciously… and regularly. In part, because of what the RBA is doing, but mostly because, regardless of the macroeconomic settings, the share market tends to continue to build wealth, over time.

You sure as hell can't say that about cash in the bank.

Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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