It may sound counterintuitive, but the cut in the official cash rate this afternoon has coincided with a bounce in the Australian dollar.
The Aussie jumped from around 69.7 US cents to just a tat under 70 US cents after the Reserve Bank of Australia (RBA) lowered the interest rate for the first time in nearly three-years to a new record low of 1.25%.
The rally didn't last long and the dollar ended back where it started but there's a reason for the reaction.
Why rates may not be going lower
It probably has to do with the less dovish than expected statement by RBA governor Philip Lowe that accompanied the rate decision, which threw future rate cuts in doubt and prompted traders to buy the Aussie.
Economists are expecting another rate cut or two (some say even three) over the next 12 months but these expectations may need to be pared.
"The Board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time," said Dr Lowe in the statement.
This suggests to me that the RBA may be happy to sit at 1.25% for a while and only a deterioration in employment conditions will convince them to cut again.
More rate cuts may not be a good thing
This could be a more prudent move as I think the impact of further rate cuts from here will be more muted as we approach the point of diminishing returns for the cash rate. It is arguably more effective to use unconventional tools, such as quantitative easing, or fiscal policy (e.g. bigger tax cuts) to stimulate the economy from here.
The RBA statement was also more upbeat than I expected as it painted a relatively positive outlook. While the central bank acknowledged the downside risks stemming from the trade war, it pointed out that "the outlook for the global economy remains reasonable" and stuck to its GDP growth forecast of 2.75% in 2019 and 2020 for the Australian economy.
The RBA is feeling confident on the forecast because the Chinese government has taken steps to support economic growth and address risks in its financial system, while inflation is low and employment and wages growth are positive for most developed economies.
"Global financial conditions remain accommodative. Long-term bond yields and risk premiums are low. In Australia, long-term bond yields are at historically low levels," said Dr Lowe.
"Bank funding costs have also declined further, with money-market spreads having fully reversed the increases that took place last year. The Australian dollar has depreciated a little over the past few months and is at the low end of its narrow range of recent times."
Foolish takeaway
It doesn't sound like the RBA is in any rush to cut rates again but some in the market may be taking the comments with a pinch of salt, probably because of our darkening employment outlook and the amount of household debt.
Having said that, quantitative easing (should the RBA decide to go down that path) is also a negative for our dollar. It's hard to say exactly what's putting pressure on the exchange rate although I think the path of least resistance is down.
