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07 December 2008

What does the future hold - one perspective from Chris Zappone of the Sydney Morning Herald

The Reserve Bank has slashed its key interest rate by more than expected in its latest effort to prevent Australia's economy from sliding into a recession.

The central bank lopped a full percentage point, or 100 basis points, off its key cash rate, reducing it to 4.25%. That level matches its previous record low - reached in the wake of the 9/11 terrorist attacks in the US in 2001 - since the RBA began targeting rates about two decades ago.

The Commonwealth Bank and the National Australia Bank led commercial lenders in responding to today's reduction, passing on the 100 basis-point cut in full to customers. Westpac, though, lowered its standard loan rate by only 80 basis points, to 6.91%.

The RBA cut marks four months in a row of reductions, as the central bank tries to shield the domestic economy for a global slowdown. A consensus of twenty economists surveyed by Bloomberg predicted the RBA would lower rates today by 75 basis points.

''It's good they've decided to move as aggressively as 100 basis points,'' said economist Stephen Halmarick of Citi. ''It just shows there is continued concern that the global economic outlook is very uncertain.''

There is already some evidence that lower interest rates are attracting people back into the housing market, said Mr Halmarick.

But he welcomed the RBA's move, because ''the headwinds coming from the global economy are getting worse and worse.''

The Aussie dollar was little changed after the rate news, buying about 63.75 US cents in recent trading. Shares are trading lower after the RBA decision with the main indexes recently down 3.2% for the day.

Mortgage savings

For a typical 25-year, $300,000 home loan, today's cut if passed on in full by lenders will save borrowers about $193 a month in payments or $58,000 over the life of the loan.
Treasurer Wayne Swan urged the other major banks to pass on the RBA's cut in full.
''This is a vital rate cut...delivered at a time when all our joint efforts are directed towards strengthening the economy and protecting Australian jobs,'' Mr Swan told Parliament. ''For these reasons the government does expect the banks to pass this on in full.''

All up, the central bank has chopped three full percentage points from the key rate since September, when concerns about a recession began to overshadow inflation concerns.
The RBA moves come a day ahead of the release of economic growth figures for the September quarter. Economists are tipping a growth pace of 1.8%-1.9% from the same quarter a year ago.

Markets remain 'fragile'

RBA Governor Glenn Stevens said that while Australia's economy had been more resilient than other advanced economies ''recent data nonetheless indicate that a significant moderation in demand and activity has been occurring.''

Some analysts predict the RBA's cash rate will fall to 2.5% by mid-2009, effectively reducing the interest rate by two-thirds within a year.

''Recent actions by governments and central banks to stabilise their respective financial systems have begun to take effect,'' he said in a statement. ''Nonetheless, financial market sentiment remains fragile, as evidence accumulates of weak economic conditions in the major countries and a significant slowing in many emerging countries. Commodity prices have fallen further.''

Inflation threat recedes

One result of the global slowdown is the threat of inflation has all but evaporated, giving central banks everywhere room to take an axe to official interest rates. The downside is that demand is also disappearing.

''With confidence affected by the financial turbulence and a decline in the terms of trade now under way, more cautious behaviour by both households and businesses is likely to see private demand remain subdued in the near term,'' Mr Stevens said. ''With that outlook, and with capacity pressures now easing, it is likely that inflation in Australia will soon start to fall.''

'Measured approach'

The language of Mr Stevens' statement signals that the RBA has "shifted to taking a more measured approach," said Westpac economist Matthew Hassan. "They brought them down to an explicitly expansionary level. And that part of the task is done."

"Now it’s a case of judging how much traction they’re getting (from the measures) to offset the weakness from abroad," he said. "Now they must judge how much traction they are getting."

"They haven’t ruled anything out with that statement," Mr Hassan said. "But they have highlighted that for additional moves we have to have some reason to believe the slowdown in Australia is more pronounced than other recessions."

A monthly survey of inflation by TD Securities out yesterday indicated prices had fallen in both October and November. Other economic data out today gave a mixed picture. Retail sales for October rose by a more than expected 0.7%, seasonally adjusted, and 0.2% in trend terms for the month. On the trade front, however, the deficit narrowed by less than expected, indicating slowing global demand is already eroding demand for exports.

Source - Sydney Morning Herald December 2, 2008 Publication

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