The Reserve Bank of Australia cut its key interest rate by 25 basis points to 2.25 percent. This is the first cut since August 2013 when the RBA reduced the rate to 2.5 percent. Most analysts expected the Bank to maintain its rate at 2.5 percent. However, for the past week Australia's markets have been anticipating the rate cut.
The RBA said that while the cash rate has been stable, as the Board has taken time to assess the effects of the substantial easing in policy that had already been put in place and monitored developments in Australia and abroad. However, taking into account the flow of recent information and updated forecasts, the Board judged "that, on balance, a further reduction in the cash rate was appropriate. This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target."
The Board noted that "the Australian dollar has declined noticeably against a rising U.S. dollar over recent months, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy."
Regarding inflation, the Board noted that the CPI recorded the lowest increase for several years in 2014 thanks to the sharp decline in oil prices at the end of the year and the removal of the price on carbon. Measures of underlying inflation also declined a little, to around 2¼ per cent over the year. "With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate."
"Commodity prices have continued to decline, in some cases sharply. The price of oil in particular has fallen significantly over the past few months. These trends appear to reflect a combination of lower growth in demand and, more importantly, significant increases in supply. The much lower levels of energy prices will act to strengthen global output and temporarily to lower CPI inflation rates."
The central bank of Australia announces its monetary policy with regard to interest rates on the first Tuesday of each month with the exception of January.
The Reserve Bank of Australia's (RBA's) main responsibility is monetary policy. Policy decisions are made by the Reserve Bank Board with the objective of achieving low and stable inflation over the medium term. Other responsibilities include maintaining financial system stability, while at the same time promoting the safety and efficiency of the payments system. The RBA regards appropriate monetary policy as a major factor contributing to the Australian dollar's stability, which in turn leads to full employment and the economic prosperity for Australia.
The RBA is unique among the central banks - it has two boards with complementary responsibilities. The Reserve Bank Board is responsible for monetary policy and overall financial system stability. The Payments System Board has specific responsibility for the safety and efficiency of the payments system.
The RBA sets an interest rate at which it lends to financial institutions. This interest rate then affects the whole range of interest rates set by commercial banks and other institutions for their own savers and borrowers. It also tends to affect the price of financial assets, such as bonds and shares, and the exchange rate, which affect consumer and business demand in a variety of ways. Lowering or raising interest rates affects spending in the economy.
The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.