Business craves policy certainty

The Reserve Bank and currency markets are helping business, but what about Canberra?

Yesterday's interest rate cut has taken the official cash rate to 2.5 per cent, its lowest level since data was first collected in 1958-59.

Hence, it was widely reported that rates have now fallen to record lows.

Looking at recent rate-cutting cycles, it’s easy to see the significance of the latest move.

In 2009, the cash rate fell to a low of 3.00 per cent in April 2009.

In the 2001 rate-cutting cycle the cash rate fell to 4.25 per cent.

And in the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.

But an interesting piece of analysis by the economics team at CommSec suggests the story is not quite that simple.

A key reason why the cash rate is at current levels is because banks have been constrained from passing on in full the rate cuts delivered over the past five years.

CommSec suggests that, in more ‘normal’ times, the official cash rate would currently be around 4.25 per cent – similar to the low reached in December 2001.

When the Reserve Bank evaluates how loose monetary policy settings are, it looks at key lending rates such as the home loan rate and small business overdraft rate.

Assuming this week’s rate cut is passed on in full, the variable home loan rate would still be around 20 basis points above the lows set in the GFC and around 1 percentage point above the lows set in 1959 and 1960.

On this analysis, CommSec concludes that interest rates are by no means at ‘emergency’ levels.

It believes that, if inflation can be contained between 2 and 3 per cent, a ‘normal’ cash rate could be around 3.5-4.0 per cent rather than levels near 5.5 per cent.

The rationale for the latest rate cut was spelt out clearly by Reserve Bank governor Glenn Stevens.

Global growth is running “a bit below average” this year, with reasonable prospects of a pick-up next year.

Similarly, the growth rate in Australia is “a bit below trend” and that is expected to continue as the economy adjusts to lower levels of mining investment.

A key target for the RBA is the inflation rate, which has remained within the medium-term target of 2 to 3 per cent.

With growth in labour costs moderating, this is expected to remain the case over the next one to two years, even with the effects of the recent depreciation of the exchange rate.

All of this is unsurprising; however the analysts who study every word emanating from the Reserve Bank picked up one significant change.

The governor’s statement was less ‘dovish’ than previous ones, because it did not repeat that the inflation outlook left further scope to cut rates.

With the lower Aussie dollar boosting the competitive position of Australian businesses, the need for further rate cuts to stimulate the economy is questionable.

After all, if households and businesses cannot afford debt finance at current interest rates, it is doubtful they will ever be able to do so.

An added factor, especially for business, is whether they have the confidence to take on debt in the current uncertain environment.

Many business people are hoping the looming federal election will deliver certainty, in the form of a stable government that understands business and pursues consistent policy goals.

Last week’s mini-budget illustrated just how far we are from that goal.

It featured a downgrade to Australia’s growth outlook, dramatic revisions to the budget outlook, and a series of major tax and spending policy changes.

National economic growth of 2.5 to 3.0 per cent is still respectable by international standards, but how does it compare to Australia’s real potential?

Giving business more certainty and, perhaps even more importantly, the freedom to pursue their growth plans is a critical change that is sorely needed.