Is Reserve Bank of Australia a New Friend of Gold?Reserve Bank of Australia joined the chorus of easing central banks, cutting interest rates to record lows. Predictably, that sent the Aussie dollar plunging. Should gold bulls cheer this move?
Reserve Bank of Australia Slashes Interest Rates
The Reserve Bank of Australia has cut the official interest rate from 1.00 percent to 0.75 percent earlier today. As the chart below shows, the 0.25 percentage point moved the interest rate to a record low level, following cuts in June and July.
Reserve Bank governor Philip Lowe explained the move as follows:
The Board took the decision to lower interest rates further today to support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target.
Lowe also provided significant forward guidance, saying that “It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target.”
Australia has avoided recession for 28 years running, but risks have increased over the last year. Let’s count the factors: slowing growth, uptick in the unemployment rate, and subdued inflation and the property market. The cut is a response to these risks, in particular to the slowdown in economic growth. The GDP expanded 1.4 percent annually in the second quarter of 2019, the worst annual growth recorded since Great Recession. However, the unemployment rate remains low, while the federal budget is essentially balanced right now.
RBA’s Cut Puzzle and Gold
So, the main macroeconomic indicators are reasonably good, but interest rates are at record lows. Doesn’t that remind you of something? Maybe the Fed’s cut puzzle? There are two explanations.
One is that the RBA has just jumped on the bandwagon of dovish U-turns among central banks. The Fed inaugurated the fresh round of global monetary easing in July, followed by the ECB in September and several other central banks have cut interest rates this year amid trade wars, slowing economic growth and subdued inflation. You see, when the Fed and ECB eased their stance, you have to follow – otherwise, your currency would appreciate. But policymakers prefer to devaluate their currencies in an attempt to stimulate exports and grow at the expense of other countries. The competitive devaluation, when intense enough, is fundamentally supportive for the gold prices.
The second possible explanation is that the recent correction in the housing prices will continue, despite some rebound. Or, that it has not been a correction, but the beginning of the housing bust. It’s true that Australia has dodged recession for 28 year, but it was largely caused by strong Chinese demand for the country’s raw materials. Now, the Chinese economy is slowing, so both the imports to China and China’s capital flows into Australia’s real estate market are falling, which finally popped the debt-fueled property bubble. It could increase the safe-haven demand for gold, but rather only in Australia. Unless, of course, the global financial crisis will start this time in the Land Down Under.
Implications for Gold
Today RBA’s interest rate cut shows that beneath the surface the Australian economy might suffer significant economic problems. Or, that the RBA has just joined to the dovish crowd so as not to lose the country’s competitiveness. Theoretically, this should be positive for gold. But, in practice, the yellow metal reacts much more to the developments in the U.S. economy and the greenback. Sorry, Aussie! The recent correction in the gold market is coinciding with recent hints from Richard Clarida, the influential Fed Vice Chair, that he does not see a pressing need for new rate cuts to push inflation back up.
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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.
Sunshine Profits‘ Gold News and Gold Market Overview Editor