Tuesday, December 02, 2008

It'll be big and there will be more: 2.30 pm AEDT today

THE RESERVE Bank is set to cut interest rates by 1.00 percentage points today and to follow up with a series of aggressive cuts that will take mortgage rates to their lowest level since the Prime Ministership of Robert Menzies.

This morning's Bank board meeting will take place amid signs that inflation has turned negative and that Australia is already in a "spending recession".

The extraordinary serious of cuts now forecast would take the Reserve Bank's cash rate from 5.25 to 2.50 per cent within six months. If most were passed through to mortgages, standard variable rates would hit 5.0 per cent, a level not seen since 1964 when mortgage rates were fixed at that level under the Coalition government of Robert Menzies.

The Melbourne Institute - TD Securities inflation gauge released ahead of the board meeting is negative for the second successive month, suggesting that prices will fall over the December quarter, paving the way for Australia's first sustained run of deflation in more than half a century.

TD Securities is forecasting that prices will fall 0.45 per cent in the December quarter and by more in subsequent quarters, pushing the annual inflation rate below 2 per cent by March and below 1 per cent by next December.

“There has been a staggering turnaround," said TD Securities economist Joshua Williamson.

"Mid year, inflation was running at an annualised pace of 5 per cent. Now, with the domestic economy in recession and commodity prices collapsing, prices are falling at an unprecedented pace. With the domestic recession only in its early stages, there seems little doubt that inflation pressures will continue to weaken, a factor that will be compounded by the global recession and a period of low or falling commodity prices."...

Negative inflation would be deeply troubling to Australian policy makers as it would encourage Australians to postpone spending in order to take advantage of lower prices, pulling down prices and spending and also employment in a self-reinforcing spiral.

Mr Williamson said business confidence had fallen to levels "entirely consistent with a recession". Retail sales had fallen in real terms for nine months and were still falling. Household wealth was being destroyed by the collapse in share prices and the early stages of declining house prices. Deutche Bank economist Tony Meer said spending had been in recession all year and had fallen to a point where the Australian economy itself would turning down. ABN-AMRO economist Keiran Davies said the economy was "probably crumbling".

Reserve Bank staff have told the board in papers prepared for today's meeting that all of the news from overseas has gotten worse since the Board's November Melbourne Cup day meeting. The International Monetary Fund has sharply revised down its forecasts, most of the major economies are now in or approaching recession, and China's economy has sharply weakened.

While Australian employment growth has held up, most of the other Australian indicators have turned down, although there are conflicting signs from business, with capital spending continuing to grow and company profits for the September quarter up strongly. On balance the board will take the view that business conditions are weakening or are about to weaken.

The Bank is reluctant to place too much weight on the Melbourne Institute's finding that inflation has turned negative, preferring to wait until the official figures are released in late January.

Working to keep prices down are big cuts in the price of petrol, a compression of retail margins as shop keepers attempt to hang on to customers, and the expanded First Home Owners Grant.

The November Performance of Manufacturing Index released by Australian Industry Group fell to a new record low Monday, with Victoria the worst-hit of all states other than Tasmania.

Bureau of Statistics figures showed Victoria's sales performance to be the worst of any state with turnover increasing a mere 0.1 per cent in the quarter and falling in real terms. Stocks held by businesses jumped sharply, implying that businesses are now accumulating goods faster than they can sell them.

Today's Reserve Bank board decision will be announced in a dramatic fashion at 2.30 pm during the middle of the parliament's question time.

Treasurer Wayne Swan urged banks to pass on "as responsibly and fully as possible" in order to help strengthen the economy.

Australian banks resisted passing on all of the November 0.75 percentage cut blaming strain on their funding costs. Most cut their standard rates by between 0.58 and 0.65 percentage points.

Mr Swan stopped short of repeating his demands of earlier this year that banks pass on the full cut.