Monday, 5 December 2011

The no brainer - the RBA cuts 25 basis points to 4.25%

Absolutely predictable and no surprise - the RBA cut the official cash rate by 25 basis points today to 4.25%. It was the proverbial no-brainer despite the hoopla from some out there who keep missing the facts month after month, quarter after quarter, that a dramatic fiscal policy tightening in concert with substantial downside risks to global conditions, no longer warrant mildly restrictive or even neutral monetary policy settings. Inflation is falling rapidly and nominal interest rates need to fall simply to match the disinflation being witnessed now.

Some of these effects were reiterated today with news that public consumption spending fell sharply in the September quarter and public investment slumped 6.7% in September for a third straight quarterly fall. After all, there are no more school halls being built. The fiscal contraction is acute and was magnified in last weeks MYEFO.

Interest rate changes are a cheap and easy way for the policy levers to be tilted to take account of changing economic circumstances. Over the past year or so, underlying inflation has fallen by around 1 percentage point (3½% to 2½%) which means that real interest rates are higher now than a year ago even with today’s rate cut. This is why additional rate cuts of at least 50 basis points will be delivered in the new year.

The critical issue is that inflation now looks like staying low into 2012. It seems the RBA will cut to around 3.5% by the middle of 2012 as it matches the disinflation that is unfolding as we write. I think the RBA is still over-estimating how high inflation will be in the medium term.

But exactly when and by how much interest rates will be cut is impossible to tell. The RBA was careful to keep the outlook open, suggesting as always, that future monetary policy settings will be set to foster sustainable growth and low inflation over time. Of course!

In his Statement, RBA Governor Glenn Stevens noted moderating growth in the world economy, including critically in China. He went of to suggest there “the likelihood of a further material slowing in global growth has increased.” That's got to be bad for Australia.

Mr Stevens also highlighted a fall in Australia’s terms of trade, a lower likelihood of a significant acceleration in labour costs (Glenn – they are actually slowing), and more difficult conditions have emerged for financial institutions in their funding.

The prospect of a free fall in inflation including a probable negative CPI to be released on 25 January will give the RBA scope to cut interest rates again when it next meets in February. If the other hard economic data and market conditions have also deteriorated, the door will be open for a cut of 50 basis points, although as we have seen recently, the RBA prefers to move in 25 point increments.

1 comment:

  1. Excellent analysis. The property doomsayers in the media these days don't have a great record, Dent, Keen, Grantham, or anyone predicting massive house price falls for Australia. They've been wrong forever!

    Interest rates are being slashed just like they were slashed last time Keen and his gloomy mates were warning about the impending 40% crash scenario for the great Aussie real estate 'bubble'.

    The RBA listened, slashed interest rates, govt handed out the stimulus, and the 'crash' was averted. It was obvious this was going to happen last time, and it will happen again this time. My advice is read up on sites like the Zetaboards Australian Property Forum if you want to know whats really going on. The bears are growing desperate and the bulls are growing confident!

    Once interest rates fall we'll see the real direction of property prices. In the meantime don't pay too much attention to the attention seeking doomsayers.

    The Aussie RE sector has strong fundamentals unlike most of the other countries those gloom-mongerers compare us to!