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Wednesday, September 03, 2008

A follow-up cut? Maybe not.

The punters in money markets have a saying. Interest rate cuts are like cockroaches – there’s never just one of them.

Late yesterday they were backing their intuition with money.

The prices on the futures market suggest they’re expecting an extra three interest rate cuts over the next 12 months, bringing about a total cut in interest rates of 1.00 percentage points – some $175 per month.

But that’s not how the Reserve Bank sees it.

It has moved rates once, and once only, before. It most recently did so with its solo rate hike in 2005.

It’s aim, as spelt out clearly in the final sentence of its seven-paragraph statement is to “bring inflation back to its 2-3 per cent target over time”.

If Australia was a car the Reserve Bank’s foot would be on the brake pedal. On Tuesday it eased the pressure on the pedal somewhat, but importantly kept its foot there...

If the car speeds up too much it’ll put its foot down again. It has no plans to lift its foot and freewheel.

It’ll get a reading on the speed of the economy this morning [WED] with the release of the Australian National Accounts.

Only if they show the economy seriously slowing will it ease the pressure on the brake again.

Private forecasts suggest that Australia’s economic growth will have slowed to 0.4% for the3 quarter and 2.9% through the year – well below the recent pace of 3.6% but not seriously below the long-term trend of 3.25%.

It’ll be a better performance than nearly every other developed economies. The US, Japan, Germany and the UK all have near zero growth or going backwards.

Whether today’s news will worry the Reserve Bank enough to cut interest rates again (or put differently – will give it enough confidence that it can safely cut interest rates again) may become apparent on Monday.

That’s when the Bank’s Governor Glenn Stevens fronts up to his half-yearly interrogation by the House of Representatives economics committee.

This one will be in Melbourne, open to the public at 9.00am at the Dallas Brooks Hall. The politicians are likely to want answers.

The smoke signals coming from the Reserve suggest that right now it genuinely doesn’t have them. In its words, the outlook is surrounded by “considerable uncertainty”.

It knows that our confidence and our spending have been hit, but it also knows that they can rebound quickly.

It takes very seriously its responsibility to get inflation back to the target zone of 2% to 3%, and short of bringing on a recession, it will do whatever it can to make sure it gets back there.

Should this interest rate cut make us too confident, too eager to rush out and spend and push up prices and make that 2% to 3% target recede into the distance, this interest rate cut will be the last.

Not for the first time the financial market punters will have got it wrong.