ASX investors have reason to cheer after the Reserve Bank of Australia (RBA) handed down its interest rate decision today.
But the Australia dollar came under pressure as our central bankers poured cold water on rate rise speculators and tapered its bond buying program.
While everyone was expecting the RBA to hold the cash rate at 0.1% this afternoon, it made it clear that the cash rate will stay at the record low until at least 2024.
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RBA's interest rate decision is good news for ASX shares
Low interest rates are good news for global equities, including ASX shares. This is because share valuations typically move in opposite direction to rates.
But the Australian dollar is positively correlated to rates. This is why the Aussie dropped from US75.7 cents to US75.5 cents on the news. Traders are paring bets that rates will rise sooner than expected.
"The Board of the Reserve Bank of Australia (RBA) today announced the holding of the Official Cash Rate at its record low of 0.10%," said the chief economist at CreditorWatch, Harley Dale.
"That is no surprise to anybody, but it's also not the real point. Speculation is running wild about interest rates rising before the RBA's long time 'deadline' of 2024 and the RBA is inching into that debate."
No rate hikes till 2024
The RBA made it clear that it won't move on rates until actual inflation is sustainably within the 2% to 3% target range.
Even though there is a notable pick-up in inflation recently, RBA thinks it will only be a blip.
"In the short term, CPI inflation is expected to rise temporarily to about 3½ per cent over the year to the June quarter because of the reversal of some COVID-19-related price reductions a year ago," said RBA Governor Philip Lowe.
"In the central scenario, inflation in underlying terms is expected to be 1½ per cent over 2021 and 2 per cent by mid 2023."
RBA rate decision tied to inflation and wages
One big reason why the RBA is unconcerned about inflation is because of wages growth – or the lack of.
That may sound funny to some. After all, the unemployment rate fell further to 5.1% in May and more Aussies are in jobs than before the pandemic.
Further, underemployment is also trending down and labour force participation is close to record highs.
But the RBA believes that wages growth will be subdued and that any increase will be gradual and modest.
Cautious optimism behind QE wind-back
However, our central bankers acknowledged that the economic recovery is stronger and has come earlier than expected.
This is probably why the RBA is sticking to using the April 2024 government bond as the benchmark for its yield target of 0.1% instead of using a later dated bond.
While the RBA will continue to buy government bonds as part of its quantitative easing (QE) program beyond the September deadline, it will purchase $4 billion a week until at least mid-November.
We may be witnessing the start of the QE taper in Australia. That won't be good news for ASX shares as investors have gotten addicted to easy money.
