Can you believe this? The Reserve Bank of Australia has cut the official Cash Rate to 1.75%

Between the release of the surprise CPI number (-0.20% quarter on quarter) last Wednesday and the RBA announcement today, the odds of a rate cut hovered around 50/50. The negative quarterly figure brought the ‘year on year’ CPI number down to 1.30%. Contributors to the surprisingly low CPI number were clothing, footwear, holiday travel and accommodation, all down more than 2.0% over the quarter.

Today the Reserve Bank rate decision was announced and the rate has been cut by one-quarter of one percent to 1.75%.

This is not really a surprise since the RBA has put significantly more attention recently on the threat of a rising Australian dollar to our prospects of making an appropriate ‘adjustment’ from a mining-led economy into a more broad-based economy. With the US Federal Reserve seeming to back away from any rapid interest rate rises there was more money moving back into what is termed ‘the carry trade’ which pushed our dollar higher.

After topping out recently at $0.7834 and falling to $0.7580 after the CPI number last week, we think the RBA decided to take advantage of the opportunity to give it a ‘shove in the back’ while the momentum was negative. Doing this while momentum was already negative is a good use of one of the Reserve Bank’s remaining 8 bullets. (at 1.75% they now have only 7 ‘bullets’ left given the typical 0.25% cut each time)

So far the currency reaction has been modest, (most of the action happened last week when the CPI number came out) but the dollar is currently sitting on an uptrend line that goes back to January. Any lower, (below $0.755) and that trend will be broken, with more downside in the dollar expected. More action could come tonight as the overseas markets start to open for the day.

The sharemarket liked the cut, rising 1.3 percent in the 40 minutes after the announcement.

The income gap between risk-free cash and sharemarket dividends continues to widen. However, as long as there is no major deterioration in economic conditions, the situation will continue to favour shares. The trade-off is that shares will continue to see bouts of volatility as the pessimism trade ebbs and flows.