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Wednesday, December 03, 2008

Making sense of the cut

David Uren says it will have the same effect as paying out $10 billion.

Ross Gittins says the Bank is responding to the recession before it arrives.

"It's as though the authorities are helping us stock up with candles and tinned food while the hurricane is still out at sea."

Here's what I said:

THE COMMONWEALTH and the National Australia Banks have slashed their standard variable mortgage rates from 7.74 per cent to 6.74 per cent, passing on in full the official interest rate cut of 1.00 percentage points and cutting close to $200 of the monthly cost of servicing a mortgage.

The cuts, not matched by Westpac and the ANZ, will take the monthly saving since since mortgage rates peaked at 6.9 per cent four months ago to $570.

Commonwealth Bank economist Micheal Blythe says the combination of lower mortgage rates, lower petrol prices, budget tax cuts and the December stimulus package will boost household disposable incomes by as much as 7 per cent.

But he warns, "while household spending ability is improving rapidly, the desire to spend is weak".

Retail figures released yesterday showed a sharp decline in discretionary spending with department store sales slipping 1.3 per cent in one month. Over the year to October sales are down 0.6 per cent.

In the past 4 months the Reserve Bank has undone 6 years of rate rises, pushing its cash rate down to from 7.25 per cent to 4.25 per cent in the boldest series of cuts since Australia was emerging from recession in the early 1990s.

The new cash rate is well below than the official inflation rate, meaning that for wholesale borrowers the real cost of money is temporarily negative...

However both the Reserve Bank and private sector economists expect inflation to fall sharply in the year ahead with one predicting an annual inflation rate of 1 per cent by the end of next year, allowing for further rate cuts.

Late yesterday the futures market was pricing in another cut of 0.75 percentage points at the Bank's next meeting in February and then further cuts to take the cash rate down to 2.75 per cent by May, its lowest level since the 1960s.

Meeting in Melbourne, the Reserve Bank board declared conditions to be "fragile, as evidence accumulates of weak economic conditions in the major countries and significant slowing in many emerging countries."

It said while the Australian economy has been more resilient than other advanced economies, economic activity was weakening and confidence was under pressure. Together with the government's $10.4 billion spending package and a "large fall in the Australian dollar" it expected its rate cuts to provide "significant stimulus".

By promising to make further adjustments "as needed to promote sustainable growth consistent with achieving the inflation target" it held open the possibility of further cuts should the last four not revive economic activity.

"The Bank isn't going to die wondering whether it has done enough to avoid a recession," said Commonwealth Securities economist Craig James.

Within minutes of the Bank's 2.30 pm announcement the Commonwealth Bank rang the office of the Treasurer to let him know it was passing on the full 1.00 percentage points. Mr Swan announced it in parliament saying it would mean "someone with a $300,000 mortgage at the Commonwealth will receive a monthly saving of $193"

"This is certainly welcome news for all who have a mortgage with the Commonwealth. Fiscal policy and monetary policy are working in tandem."

The Reserve Bank made the move in the shadow of news overnight that the United States had fallen into recession joining Japan, the United Kingdom, much of mainland Europe and New Zealand.

The Australian statistician will today provide a long-awaited update on Australia's performance with figures expected to show that economic growth was close to zero in the September quarter.

Trade figures released yesterday showed an apparent improvement in Australia's current account deficit with exports outpacing imports. But abstracting for the lower Australian dollar and high commodity prices the volume of exports failed to keep pace with imports. Net foreign debt rose climbed 7 per cent in the September quarter.