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Wednesday, August 06, 2008

Going down

One rate cut at a time

Australia’s Reserve Bank has put beyond doubt its desire to cut interest rates, saying in a statement after its Board meeting that the scope for cutting rates is increasing.

The confirmation, in the final paragraph of the statement, reads, “with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.”

“There is now an explicit bias to ease,” said BT Group’s chief economist Chris Caton on reading the statement.

“The Bank has cleared the way for a September rate cut,” said Wespac’s chief economist Bill Evans.

Within minutes of the statement the futures market had priced in a 100 per cent probability of a cut at the Reserve Bank’s next board meeting on Tuesday September 2...

Before the statement the market priced in an 86 per cent probability of a September cut and a 14 per cent probability of no change.

The turnaround reflects the statement’s unusually direct hint that the board is considering cutting rates and also the absence of the usual assertion that “the current stance of monetary policy remains appropriate”.

Mr Evans said the last time the bank changed direction on rates in February 2005 it used similar wording to prepare the markets for a move the following month.

“We would put this statement firmly in that same category, and therefore expect a rate cut in September, as long as the intervening data does not warrant a substantial upgrade of the outlook for demand,” he said.

The bank will spell out its intentions more clearly in its major quarterly report on the economy next Monday.

Tuesday’s statement confirms that the Bank expects inflation to remain near its current long-term high of 4.5 per cent for some time before falling back to the Bank’s 2 to 3 per cent target zone in 2010.

It says household spending is “subdued” and credit growth has slowed significantly. Business activity is “softening”, and there are early signs of an easing in labour market conditions.

The statement makes clear that this is the sort of slowdown the bank has been trying to achieve with its series of four interest rate hikes since August last year.

It says additional hikes imposed by lenders themselves have resulted in “further tightening” over the past couple of months.

“The evidence is that the tightening in financial conditions, in conjunction with other factors including rising fuel costs and lower asset values has restrained demand,” the Bank said.

The statement notes that Australia’s rising export income “is working in the opposite direction” but it says on balance it expects Australia’s economic growth to be “fairly slow”.

The Treasurer Wayne Swan said it was unhelpful to talk about recession that the government would “use all the levers that we have, that we control, to get the desired outcomes”.

The Chief Executive of the Australian Industry Group Heather Ridout called on Australia’s banks to fully pass on any interest rate cuts instigated by the Reserve Bank and not to increase rates in the meantime.