MAKING NEWS

Sun, 23 November 2008
Reserve Bank Points To Another Big Interest Rate Cut
ANOTHER large interest rate cut is expected next month as the Reserve Bank has resolved to reverse its policy of high interest rates as quickly as possible.

Financial markets expect the rate cut at the December 2 meeting will be either 0.75 or 1percentage point, bringing the official cash rate down to at least 4.5 per cent and standard mortgage rates down to about 7 per cent.

The minutes of the bank's last board meeting, released yesterday, disclose that its directors wanted to get rates down to a "neutral" level: that is, neither slowing the economy nor encouraging people to go out and borrow.

The directors focused on the deteriorating outlook and the risk that economic growth would be even worse than the downgraded forecast of 1.5 per cent that the bank's executive had presented.

"Given the changing balance of risks, there was an advantage in moving the setting of monetary policy quickly to a neutral position," the minutes say.

The Reserve Bank's 0.75 percentage point rate cut at its Melbourne Cup Day meeting was controversial and caused heavy losses in money markets, as senior bank officials had hinted in previous weeks that continuing high inflation limited the scope for future rate cuts.

The minutes confirm there was a change of opinion led by the bank's governor, Glenn Stevens, on the day of the meeting.

The board papers, which had been sent to directors on the previous Thursday, had recommended only a 0.5 percentage point cut. "At the meeting, the governor proposed that members consider the choice between a reduction of 50 basis points and one of 75 basis points," the minutes say.

"Key factors in (directors') consideration of the policy decision were the continuing poor conditions in financial markets, the significant deterioration in the outlook for the world economy, with implications for Australia, and the likelihood that inflation in Australia would continue to fall over the year ahead."

The meeting also considered the results of the bank's liaison program with business.

While bank officials including deputy governor Ric Battellino had been expressing public concern about the inflation remaining higher for longer than previously thought, the bank's minutes record that directors did not think expectations of rising prices would become entrenched.

The bank's board expects the global economy to remain weak for the next several years, and says this will suppress inflation.

The turbulence in world financial markets, the big depreciation in the Australian dollar and the continuing poor availability of credit influenced the board's decision to raise rates by more than the bank's executive had recommended.

The bank does not have a set "neutral" level for interest rates. However former governor Ian Macfarlane once nominated a range of between 5.5 and 6 per cent.

The rising margin between the Reserve Bank's cash rate and the lending rates of the private banks means that a "neutral" cash rate would be between 0.5 and 1 percentage points lower now.

Westpac interest rate strategist Damien McColough said the margin between the official rate of 5.25 per cent and the banks' domestic wholesale funding rate had shrunk to only 0.3 percentage points. However, he said banks were being restrained from cutting mortgage rates further because competition for deposits had been intense.

Most of the banks are offering more than the official cash rate on term deposits, with AMP Banking offering as much as 7 per cent.

UBS interest rate strategist Matthew Johnson said markets believed the Reserve Bank would opt for a 1 percentage point cut at its December meeting, as it is not scheduled to meet in January. But directors may decide to hold a January meeting, as they did in 1990 during the last recession.

Source:"The Australian"





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