Saturday, October 11, 2008

What to expect for Christmas

Another 100 points.

That's another complete percentage point. So says Macquarie's Rory Robertson:

"**Tuesday's 100bp cash-rate cut from 7% to 6% provided a win for pretty well everyone. Borrowers got a sizeable drop in borrowing rates (80bp off headline mortgage rates), lenders got additional support for their lending margins, and the RBA neatly side-stepped many of its critics by cutting rates decisively.

**And Canberra cheered loudly, like the rest of us. That's because, of all the policy responses available to support ongoing economic growth, large RBA rate cuts were/are the most obvious, and the most powerful.

**After all, much of the developing weakness in the Australian economy in 2008 until now has been a function of the cyclically elevated policy and lending rates that the RBA deliberately put in place to contain previously elevated inflation pressures.

**Now that the world economic and financial backdrop has turned so nasty, those cyclically elevated policy and lending rates no longer are required: if headline mortgage rates above 9% and many business-lending rates above 10% were 1-2pp too high before Tuesday's cut (see attached), they still are too high...

**And the RBA knows it. "Neutral" rather than restrictive monetary policy probably now is appropriate, and that suggests a 5% cash rate, given 2008's elevated spreads/margins/risk aversion.

**My assessment is that another 100bp or so worth of RBA cuts before Christmas is likely, in one step or two. Given the fragile situation globally, the RBA's next cut could easily be 100bp again, although its statement on Tuesday did try to steer us towards thinking in terms of smaller moves.

**The "word on the street" is that Tuesday's 100bp cut was a judgement call by Governor Stevens - departing from his 50bp-Board-Paper recommendation last week - after things went so badly in global financial markets last weekend and then Monday. (If he again cuts by 100bp, The Daily Telegraph might reverse itself and go with a front-page banner headline that says "The Most Useful Man In Australia"?)

**Some observers now see the RBA as one of the few central banks in the world that "gets it", that understands the severity of the alarming financial stresses building globally, and is responding accordingly. They wish the Big Three central banks - the Fed, ECB and BOE - had followed the RBA's lead this week, with synchronised moves of 100bp rather than just the 50bp cuts that had become long overdue.

**My guess has been that the RBA's six-year tightening cycle - hiking from a cash rate of 4.25% to 7.25% between May 2002 and March 2008 - would be fully reversed within two years (see attached). Tuesday's 100bp cut obviously took us a long way fast towards that 4.25% target.

**Now, with the global credit crunch continuing to intensify, to say the least, it's easy to think the move back to 4.25% (or lower) will occur within a single year (within six months?). So here we are, expecting another 100bp worth of cash-rate cuts within the next two months."