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Don't believe the rate-cut hype

It's the monthly circus. Respected economists line up to share their predictions of what the Reserve Bank will do on interest rates.

They look at not what it should do, mind you, which is what they are trained to evaluate, but instead have a stab at guessing whether the RBA will move rates at this meeting or the next one … if at all.

Bouquets and brick-bats

The boffins who get it right are lauded for their predictions and those who get it wrong are left trying to explain how … as if somehow these arbitrary 30-day cycles are meaningful in the longer term.

Let's be clear, the RBA meets each month (except January) to work out whether the economy has changed - or is likely to change - sufficiently that the board needs to alter the official cash rate.

In an economic cycle measured in years, the difference between an October rate cut and a November one is likely to be less than 2 per cent of an average cycle's length.


As with all these things, the timing of the cut, and even its size, is largely irrelevant as a single data point. The longer-term trend is always more important – and immensely more relevant.

That the RBA is cutting rates further points to its concern that we need additional protection from the global economy and that the fragile local economy (sans mining) might sputter without additional help.

Clouds on the horizon

Fair enough too.

I have to admit I was surprised, though. There are signs of life in the US economy, and the Europeans are still working through their problems, but at least, so far, things are not getting any worse in the eurozone.

The recovery overseas is still sluggish, as the RBA noted, but when reading the central bank's statement, it was hard to escape the feeling that when governor Glenn Stevens talked about the world economy, he was really talking about China.

Chinese growth has been from two sources in recent years – the astonishing rate of infrastructure development, and its role as the world's factory. With the rate of infrastructure growth likely to be lower in future years, Chinese demand for raw materials will also increase less quickly.

European demand, or lack of it, for Chinese-produced goods also appears to be continuing to slow – meaning less demand for the inputs into that production.

When China sneezes …

That's not great news for Australia's economy. There is tacit acceptance that the RBA expects the Australian economy to be less robust in the coming months than was previously expected to be the case.

And it is terrible news for our miners, in particular. The RBA's actions are designed to limit any contagion as much as possible. Investors in mining companies won't have any such protection if the worst comes to pass.

In the wash-up, attention has turned to companies that are likely to benefit from the new rate cut. Discretionary retailers, home builders and exporters will benefit from a less cautious consumer and a relatively lower Australian dollar.

On the surface that's right – these industries benefit from lower rather than higher interest rates. We have to be a little careful, though – just because they're relatively better off with lower rates doesn't mean we should be popping the champagne just yet.

Smoothing out the bumps

Remember, the RBA isn't changing rates out of the goodness of its heart – it is inoculating the economy against future weakness. Remember, also, the role of the central banker is to smooth out the peaks and troughs, not be head cheerleader.

In other words, the latest rate cut is the equivalent of getting the road crews ready to quickly fill in the potholes that will appear, and to stop others forming, not building a brand new super-highway to the promised land.

Of course, the companies in question will do better with a cut that without one, but the RBA's actions will just bring us back to balance – not drive the economy to new heights.

Foolish takeaway

If your prior view was one of impending pain and destruction, the latest rates decision will likely give you new hope. But for those who realise economies move in cycles, the decision and its implications shouldn't be surprising.

Remember, there are no prizes for guessing what would have happened if the RBA sat on its hands: it won't.

Those investors abandoning interest rate-sensitive companies in the past should have remembered that the RBA would always act when necessary. Others rejoicing now it has (and pushing prices up) should have expected it all along.

A rate cut means the economy would otherwise be weaker than expected, while keeping rates on hold would have meant all is in order. In both cases, the RBA is aiming for a smooth ride – and investors would do well to not overreact.

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Scott Phillips is a Motley Fool  investment analyst. You can follow Scott on Twitter.  The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).