02/05/2012 - 11:15

Applause all round for RBA move

02/05/2012 - 11:15

Bookmark

Save articles for future reference.

The RBA’s interest rate decision this week signalled some big changes in Australia’s banking industry, and continuing risks in the global economy.

The RBA’s interest rate decision this week signalled some big changes in Australia’s banking industry, and continuing risks in the global economy.

THE Reserve Bank rarely wins universal praise for its interest rate decisions but it seems to have achieved that feat this week.

It surprised just about all market pundits by cutting the official cash rate by 50 basis points, double the expected reduction.

But it didn’t disappoint anybody. Retailers, builders and other business groups that have been struggling in the slow part of the ‘two speed’ economy were elated by the Reserve’s decision.

Ironically, it looks like we can thank the commercial banks for the Reserve’s decision to make such a large cut.

The commercial banks have attracted the ire of many groups by lifting their lending rates, separately from any move in official rates.

That is a major departure from traditional practice, based on the banks’ argument that their funding costs are subject to multiple influences, including movements in wholesale market rates.

The link between the commercial banks’ actions and the Reserve’s decision was revealed by governor Glenn Stevens, with his typically cautious and subtle language.

“In considering the appropriate size of adjustment to the cash rate at today’s meeting, the board judged it desirable that financial conditions now be easier than those which had prevailed in December,” Mr Stevens said in a statement.

“A reduction of 50 basis points in the cash rate was, in this instance, therefore judged to be necessary in order to deliver the appropriate level of borrowing rates.”

In other words, the commercial banks have been lifting their lending rates, or failing to pass on earlier cuts to the cash rate, therefore the Reserve had to push through a bigger cut.

AMP Capital Investors chief economist Shane Oliver put it neatly when he said the Reserve was moving to “reverse the defacto monetary tightening we have seen so far this year thanks to higher bank lending rates”.

Mr Oliver added that the economic environment has clearly turned out very differently to what the RBA was looking for just a few months ago.

Mr Stevens’ statement was full of references to softness: below trend global growth, below trend output growth in Australia, a softening in labour market conditions, modest credit growth, a subdued housing market and a decline in inflation.

The Reserve expressed particular concern about the condition of Europe, a topic Steve Blizzard addresses on the facing page.

“Market sentiment remains skittish, however, and the tasks of putting European banks and sovereigns onto a sound footing for the longer term, and of improving Europe's growth prospects, remain large,” Mr Stevens said in his statement.

“Hence Europe will remain a potential source of adverse shocks for some time yet.”

The news was better elsewhere, with growth in China and Asia off its peaks but more sustainable, and the US continuing to grow at a moderate pace.  

Looking ahead, the response of consumers and home buyers to the rate cut will be critical.

As CommSec chief economist Craig James put it, if the rate cut doesn’t cause people to buy or build more homes or spend, employ or invest then the rate cut is a ‘damp squib’ – it is akin to pushing on a piece of string.

Similarly, he said that if home-buyers elect to pay off their home loans quicker, then extra spending power won’t be released into the economy. 

The best outcome will come with a lift in confidence, and that’s where politics starts to intersect with economics.

The federal government is wracked by controversy and its longevity seems constantly in doubt, yet treasurer Wayne Swan is talking about tax increases and spending cuts so he can deliver the long-promised budget surplus next financial year.

The release next week of the federal budget will put an end to some of the unsettling speculation, but it’s unlikely to deliver the stable, consistent and predictable government Australians crave.

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

Subscription Options