What if the RBA drops the cash rate to 1%?

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In late January and early February our market had a remarkable rally, rising 10%-plus in 11 days. The main catalyst was the decision by the Reserve Bank to cut interest rates from 2.5% to 2.25%.

In itself a small cash rate cut is no big deal but, when you consider the reversal in expectations that has just happened, you begin to wonder just what brought it on.

Since December we have moved from expecting the cash rate to rise to an actual cut and forecasts of a string of cuts to come.

rba cash rate 1%

My guess is that the RBA has come to an ugly realisation: that while the price of iron ore and oil has halved, our two-speed economy has been accelerating through its "gear change" from commodities to something else - and there's nothing there, just a big economic void. All the RBA can do is rather inadequately cut rates too late.

And as it cuts rates - like the emperor with no clothes - everything is suddenly out in the open and we are abruptly questioning why interest rates have stayed at 2.5% for so long when the US, Europe and Japan are working off negative to zero rates.

It seems our interest rate policy has been set on the basis of a resources boom that has ended. In fact, it ended in 2011, if not 2008. Monetary policy has been resting on a relic.

Rates have been too high for too long and the RBA move has awoken us to the possibility that our cash and bond rates should be zero to 1% too - and are on their way there.

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