Australia | Oct 02 2008
By Greg Peel
Before the world global financial markets and economies were suddenly about to collapse – way, way back in like August – Australian economists were relatively convinced the Reserve Bank of Australia would hold off on delivering another 25 basis point cut until at least after November’s quarterly CPI and GDP figures were released, having already delivered a 25 point that month.
This was the first cut to signal a change in monetary policy following the long run up to 7.25% – a level that was set in order to combat Australia’s burgeoning inflation problem. Economists were anticipating further cuts in 2009 as the world economy slowed and inflation pressure eased.
But now, all bets are off, at least as far as futures markets are concerned. Futures prices are predicting that not only will the RBA definitely cut by 25 points next week, there is more than a 90% chance that cut will be 50 points. What’s more, the market expects another 50 point cut by end-December and yet another by end-March. That would take the cash rate to 5.5%, if futures are any guide.
The reason for the sudden change of heart is, clearly, the immediate global economic crisis and the complete freezing of credit markets that have forced bank borrowing costs through the roof. Were the RBA not to cut this month, as it was not likely to previously, there is every chance banks and other lenders would have had to raise their lending rates once more. That is also why the market is looking for a 50 point cut next week, given banks may not even to be able to move on a 25 point cut. A 50 cut from the RBA would probably bring 25 or so from the banks, thus providing some mortgage and other loan relief in a slowing Australian economy.
TD Securities senior strategist Joshua Williamson is not buying it, however, suggesting only 25 basis points will be forthcoming from the RBA on Tuesday. Were the RBA to cut by 50 points it would be to admit defeat against inflation, Williamson suggests. This would not be a good look from one of the world’s most inflation-averse central banks.
But really, it’s got nothing to do with perception or reputation. The RBA has a very difficult choice to make. It wants the Australian economy to slow down, but not to collapse. A big rate cut at this time runs the risk of finally losing grip on the inflation leash, and sending Australia into a devastating period of prolonged stagflation.
The oil price may have come down by a third, and so too prices of other commodities, but that does not mean Australia’s inflation threat is now over. At the last read core inflation was running at a very high 4.5% to the headline reading of 5%, meaning there’s a lot more than just oil and food prices involved. And Williamson can rattle them off:
(1) Unemployment is only two percentage points from the 35-year low; (2) the labour shortage means wage growth is still at a decade high; (3) the housing shortage means rents continue to soar; (4) retail sales remain strong (at last count) given tax cuts and lower petrol prices; (5) state government infrastructure spending is in a boom; (6) private sector investment remains robust; and (7) the Aussie dollar has weakened substantially, making imports more expensive and assisting export sales meaning more income and more spending.
On that basis, Williamson believes the global financial crisis (even assuming the successful passage of the US government’s rescue bill) may be daunting, but still not enough for the RBA to simply abandon its sworn responsibility of bringing core inflation back into the 2-3% range – something only an economic slowdown could achieve.
Could this mean another recession we have to have?
Williamson believes the RBA will cut by 25 basis points on Tuesday, 25 in November and another 25 in February.