Wednesday 3 October 2012

Australia Reserve Bank reduces bank rates

Rate cut signals end of boom, warns RBA

Reserve Bank
The Reserve Bank has cut interest rates to 3.25 per cent, a fall of 25 basis points. Source: The Australian
THE Reserve Bank is calling the end of Australia's resources boom next year, as mining projects are shelved or cancelled amid growing concern about the downturn in China.

The Reserve Bank yesterday cut the official cash rate by 0.25 percentage points to 3.25 per cent - taking cuts in the past five months to a full percentage point - as governor Glenn Stevens warned that weaker Chinese growth was affecting the rest of Asia and forcing a downgrade in Australia's growth outlook. "On the back of international developments, the growth outlook for next year looked a little weaker," Mr Stevens said.

Financial markets expect the Reserve Bank to follow yesterday's cut with a further 25-basis-point reduction at its board meeting on Melbourne Cup day next month, which would take official rates back to their low point during the global financial crisis.
The Reserve Bank is likely to trim its forecast for Australia's growth in its next economic review, due next month. However, Wayne Swan said the nation's economy was still growing at its trend rate and the government remained committed to its aim of returning the budget to surplus this financial year.

The Treasurer said the Reserve Bank's decision was a win for families struggling with mortgage costs and argued that the succession of interest rate cuts this year "have been made possible by our responsible budget policy".

Standard variable mortgages have come down by 55 basis points to 6.85 per cent since May and would fall to 6.6 per cent if banks passed on the full cut. This would represent a $150-a-month saving on a $300,000 mortgage since May. However, bank funding costs are under pressure. Ratecity, a firm that compares bank lending rates, said it did not expect many lenders to pass on the full 25-basis-points cut.

Mr Swan has repeatedly pointed to a continued multi-billion-dollar boom in resources industry investment despite the recent slump in commodity prices. Mr Stevens indicated that the sharp fall in commodity prices over the past few months was forcing resource companies to reconsider their investment plans. "The peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected," he said in a statement that accompanied the rates decision.

Mr Stevens said Australia's terms of trade - export prices compared with import prices - had dropped 10 per cent and were likely to fall lower. Although iron ore prices had stabilised over the past month, coal prices had continued to fall. "Economic activity in Europe is contracting, while growth in the US remains modest," he said, adding "growth in China has also slowed, and uncertainty about near-term prospects is greater than it was some months ago".

In August, the Reserve Bank projected that resource investment would peak at 9 per cent of gross domestic product sometime next financial year, but now anticipates a weaker peak in 2013, roughly six months earlier.
Phil O'Donaghoe, a Deutsche Bank senior economist, said the rate cut reflected a desire to shore up the non-resource sector. He said slowing economic growth would make it more difficult for the government to achieve a budget surplus.

Joe Hockey, opposition Treasury spokesman, said Australia could no longer rely on record high commodity prices to boost economic growth and the budget bottom line. He said the rate cut reflected weakness in the economy and noted that Mr Swan had previously described the 3 per cent interest rate reached during the global financial crisis as an "emergency level".

Mr Swan conceded that Australia's lower commodity prices, a higher Australian dollar and heightened global uncertainty had contributed to the bank's decision: "But we should also keep a very keen eye on our fundamental strengths: low official interest rates, contained inflation, solid growth, low unemployment, healthy consumption and a very big pipeline of investment."

Westpac chief economist Bill Evans said the RBA had become more downbeat about the labour market, where jobs growth had remained weak despite a relatively low unemployment rate. The bank had shifted its focus from containing potential price pressure from the mining boom to stimulating struggling construction and retail sectors. Most economists had expected the RBA to wait until next month before cutting rates. The bank's statement once again said the exchange rate "remained higher than might have been expected" given the fall in export prices.

The Australian dollar slumped more than half a cent to US103.4c against the US dollar following yesterday's cut. "We suspect the RBA is likely to continue to be surprised by the resilience in the Australian dollar," Mr O'Donaghoe said. Recent rate cuts have had little lasting impact on the dollar's value. Financial markets are trading on the basis that there is a 73 per cent chance of a follow-up rate cut next month.

However, Mr Stevens's statement gave no clues, simply commenting that the weaker global outlook meant that monetary policy could now be "more accommodative". Innes Willox, chief executive of the Australian Industry Group, welcomed the move, reflecting ongoing concerns among unions and businesses that the economy was weaker than official statistics suggested and Australia's currency was stubbornly high, partly because local interest rates were high compared to other countries.

"This rate cut will hopefully give a shot in the arm to key employing industries across the economy, including manufacturing, construction and services," he added. Greg Evans, head of policy at the Australian Chamber of Commerce and Industry, said that the cut would "boost consumer confidence, take pressure off household budgets and ease business borrowing costs".

Attention will now turn to how much of the rate cut the major banks will pass on to mortgage rates, which Mr Stevens said had "for some months been below their medium-term averages". Wilhelm Harnisch, chief executive of the Master Builders Association, said it was "now up to the commercial banks to do their bit and pass on these rate cuts in full to their customers, small businesses and homebuyers to help stimulate the economy".

The Reserve's third cut this year, one percentage point in total, brings official rates to their lowest level since late 2009. But the gap between the official interest rate and mortgage rates has increased by about 1.5 percentage points since then, as banks have withheld some of the cuts rather than pass them on to borrowers or increased rates independently of Reserve Bank movements.

"A more competitive market for deposits and tougher wholesale funding conditions for Australia's major banks is the explanation," Mr O'Donaghoe said.National Seniors chief executive Michael O'Neill said that the downward movement in rates had come as a shock to older Australians, many of whom relied on fixed income from deposits.

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