Wednesday, October 19, 2011

Field guide: What'd give us a Melbourne Cup Day rate cut

The Reserve Bank has spelled out the conditions under which it would cut interest rates at its next meeting Melbourne Cup Tuesday.

Board minutes released yesterday show Bank economists have scaled down their estimate of underlying inflation from 2.5 - 2.75 per cent, near the top of their 2 to 3 per cent target band, to 2.25 to 2.5 per cent.

If the Bank can tell ‘a credible story’ about how inflation is set to stay at around 2.5 per cent, it will cut its cash rate 0.25 points.

The cut would be presented as a technical adjustment to a changed inflation outlook rather than as a response to a weak economy.

It would be described as a ‘one-off’ - moving settings from mildly restrictive to neutral - rather than as the first of a series of cuts...

A cut in the cash rate from 4.75 per cent to 4.5 per cent would cut the typical variable mortgage rate from 7.8 to 7.55 per cent, slicing $49 off the monthly cost of servicing a $300,000 mortgage in the lead-up to Christmas.

Futures markets expect the Bank to go further, cutting rates three times by February.

Late yesterday traders lifted the implied probability of a Melbourne Cup day rate cut from 64 to 70 per cent.

But the bank won’t make the cut at all unless it is convinced it can credibly say inflation will remain contained. Helping it will be updated information on spending patterns obtained by the Bureau of Statistics which makes inflation look “less concerning” and reports from its business liaison program that outside the mining sector wage pressure is easing.

The Bank will need both a benign inflation outcome in the September quarter figures to be released next Wednesday and a set of believable forecasts for continued benign outcomes.

If decided on by the board the cut would be the first since the global financial crisis. It would also be the first one-off cut not clustered with others since December 1998.

While the Bank believes the non-mining economy is subdued it expects it to pick up. It is particularly sceptical of the official employment figures which show weak or negative jobs growth, noting that at the same time job vacancies are increasing and the number of people on unemployment benefits is falling.

“The Bank is considering a cautious policy tweaking rather than an interest rate slashing,” said ANZ senior economist Craig Michaels. “It looks like an insurance rate cut rather than a string of them.”

Access Economics forecasts due for release this morning (WED) have interest rates falling just once between now and March and not falling further. While Access does not think there will be a new global financial crisis it does think the risk has increased.

“If there is one, we would look to the Reserve Bank to do more than it did in the last crisis and for the government to do less. But ‘doing less’ is not ‘doing nothing’. For all the unpopularity of the recent stimulus spending, it did its job very well,” Access director Chris Richardson writes to clients.

Chinese figures released yesterday showed economic growth moderating from an annual 9.5 per cent to 9.1 per cent.

“It remains strong,” said HSBC economist Qu Hongbin. “Sluggish western economies will weigh on exports, but the domestic economy is supported strong retail sales growth, rising continuing infrastructure investment and accelerated public housing construction.”

“Even if western economies slip into a renewed recession the impact on China's growth will be much smaller than three years ago.”

Published in today's SMH and Age

Related Posts

. What an about-face. The Reserve is about to cut rates.

. Attention Reserve Bank: Inflation is not as bad as it looks

. Where were we? What's wrong with the CPI

. Inflation is not what it was - that's official

. Rising unemployment? I Don't believe it - RBA deputy