The RBA justified the rate cut by blaming the continuous low inflation. They are hoping that by announcing a lowering of the rate to 1.5%, they will stimulate the economy by spurring investment and inflation. While keeping a downward pressure on the Aussie dollar.
But, will another cut rate have any effect where it has already failed before?
Interest rate cuts are becoming ineffective when it comes to stimulating the economy. They are failing at increasing consumption. You see, Australia has an increasingly ageing population. And as the population gets older, they are keen on reducing debt instead of increasing it. People are becoming reluctant at taking on anymore debt.
The Australian economy is not the only one battling with low inflation, low growth and low wages. The US announced earlier this week weaker than expected economic figures. The economy only grew at a lowly 1.2% in Q2, instead of the expected 2.6%.
And the US is not the only one. Many of the European banks and even Japan have already cut rates to below zero. There is even talk of deflation.
For the banks, low rates are also bad news. The low rates mean that bank profits are getting squeezed. And they have already announced that they will not be passing on the full cut on to customers.
Plus, there is the added concern that lowering interest rates will make debt cheaper, increasing household debt. Household debt to GDP ratio in Australia is one of the highest in the world. Mostly due to the increases in property prices. And there are concerns that the already overvalued housing market will keep on growing with cheap debt.
We are entering into unknown territory. Rates have never been this low before for this long. And they have never been as ineffective at creating inflation.
For The Daily Reckoning
PS: Selva recently joined the Port Phillip Publishing team as our macroeconomic analyst. She works closely with The Daily Reckoning editor Vern Gowdie on his advisory service,The Gowdie Letter.