Australia | Nov 04 2008
By Greg Peel
There was never any doubt the Reserve Bank of Australia would cut its cash rate by something today. The US cut by 50 basis points to 1% last week and the Chinese cut to 6.66%. Even the Bank of Japan cut, from 0.5% to 0.3%, and Europe and the UK are expected to follow later in the week. The world economy is slowing sharply and Australia is not immune. In order to prevent too sharp a slowing, and even possible recession, the RBA needed to act incisively.
The 100 point cut last month came as quite a shock in its magnitude, although since that time the RBA had come in for praise both locally and abroad for its timely action. Economists have since expected further cutting towards year-end but there was some hint in the last RBA statement that inflation problems may still act as a dampener to further drastic action. It was with that in mind that economists decided another 50 points in November would be sufficient.
Nevertheless, with a barrage of late mail in the form of weak job ads numbers, weak manufacturing activity and weaker house prices, punters were firming the odds this morning that perhaps another full 100 points might be on the cards. Or at least 75.
And 75 points it was, taking the cash rate to 5.25%.
The reason was made clear in the accompanying statement, although there were no surprises. “International economic data have continued to point to significant weakness in the major industrial economies,” Glenn Stevens notes, “and there have been further signs that China and other parts of the developing world are slowing as well”. While Australia’s economy had been previously slowing in line with what the RBA had wanted from its earlier tightening phase, now “On balance, it appears likely that spending and activity will be weaker than earlier expected”.
Inflation was nevertheless high on the last measure, but the RBA had expected this all along. With capacity pressures now easing it is assumed inflation, too, will ease, and the latest unofficial data confirmed the beginning of this trend. Global disinflationary pressure will surely help, however “the depreciation of the exchange rate,” notes Stevens, “means that the decline of inflation to the target [2-3%] could take longer than would otherwise be the case”.
While the RBA has always warned that inflation has the power to stay high for some time even as economic growth slows, and that Australia’s terms of trade will be supported by last year’s bulk commodity price negotiations before new prices are set next year, this nod to the exchange rate is a first. It is not surprising, given the Aussie has collapsed in the space of a month.
The RBA has thus noted that economic activity might be weaker than expected, which could be justification for a 100 point cut perhaps, while inflation will be influenced by the Aussie, which could perhaps make the argument for 50 points.
So 75 seemed the obvious choice.
It also means that what happens next month is again up for conjecture. Had the RBA cut by 50 today then economists would have chorused their expectation of another 50 in December. Does that mean we should now only expect 25 in December?
It’s now a bit hard to pick what might happen, given the dramatic change in events currently occurring from one month to the next. Let’s just hope for at least a nice November stock market rally first.