Wednesday, November 16, 2011

Not many more rate cuts - Reserve

The Reserve Bank believes it has room for at most one more rate cut, not the four being priced in by financial markets. And it isn’t at all certain spending cuts of the kind expected in the upcoming mid-year budget review will enable it to cut further.

The Bank’s Melbourne Cup day board minutes released yesterday reveal it was lower inflation rather than budget settings or concern about Europe that persuaded it to cut its cash rate from 4.75 to 4.5 per cent.

It believes 4.5 per cent brings the overall mix of Australian interest rates close to the average for the past fifteen years, a period when average inflation was near the centre of its target band as it is now.

Any more than one further cut would bring the mix of interest rates below their long-term average, something that would be hard to justify unless inflation fell away further.

Cuts in the mid-year budget review could only force the Bank’s hand if they further depressed inflation, something that is far from guaranteed. The expected cuts amount to $5 billion, big by budgetary standards but worth only 0.4 per cent of gross domestic product - not necessarily enough to dent consumer and business spending and weaken inflation...

Finance Minister Penny Wong yesterday talked up the expected cuts saying returning the budget to surplus on schedule in 2012-13 would give the Bank room to further cut interest rates.

"We've seen a weakening of the world economy. That's going to impact on our economy and our budget. That means some difficult decisions in the upcoming mid-year outlook," Senator Wong told ABC radio.

"The government is focused on fiscal discipline - we know that gives the Reserve Bank more room to cut interest rates as they did last week."

She told an Institute of Public Administration forum in Canberra the spending cuts would be important in demonstrating to the community and to markets there was a clear path to return the budget to surplus.

“It is a discipline to which we are holding, notwithstanding the task is more difficult given the obvious consequences of a weaker global outlook, a softer domestic economy as well as the persistent legacy effects of the global financial crisis on revenues,” she said.

The cuts would demonstrate Labor understood “the importance of social services and a strong safety net” - programs that could only be delivered if they were sustainable.

Health care costs were set to triple by the middle of the century.

“To be able to deliver a high level of care – even with increased funding – we will need to maximise the effectiveness of expenditure. This is not just a matter of cost cutting; it requires new policies and programs that will deliver high quality care,” Ms Wong said.

Westpac economists said yesterday the cuts would most likely have to come from spending on health, social security, education and defence, which between them amounted to two thirds of government spending. Another option was increased taxes.

Over the last 16 budgets from 1996 only four had delivered net savings, the first two budgets of the Howard government and the first of the Rudd government and the first of the Gillard government. Only one - John Howard’s first budget delivered savings in excess of 0.3 per cent of GDP.

Published in today's SMH and Age

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