The US Federal Reserve’s half a per cent cut in its key interest rate may have lifted the spirits of the animals in the markets but in Australia it’s had an additional and more tangible benefit: easing the squeeze in short-term money markets.

Stockmarkets and commodities may have boomed, and 10 year US Government bonds risen in yield (as the US dollar again fell), but here in Australia the Fed’s cut had the impact others in the US, Europe, Canada and Britain were looking for, but didn’t see.

There was a noticeably larger than expected drop in our short-term rates yesterday to the point where the yield on the key 90-day bank bill fell to 6.85%, its lowest level in three weeks. It is now well under the highs of early last week when yields hit 7.10% (and 7.11% for the 180-day bills).

This means the pressure is easing for a lift in mainstream mortgage interest rates above the rise forced on lenders by the RBA’s 0.25% rate rise last month. In fact the RBA tested the easing conditions yesterday by injecting the smallest amount of money it has for some weeks: only $495 million in repurchase deals were done yesterday, despite the system being down more than $900 million.

It’s the first time rates have eased with the RBA injecting less than the system deficit, although the Exchange Settlement Account was left flush overnight with around $4 billion in the account.

Indeed the ANZ told bank analysts yesterday that while its cost of funds has increased, particularly at the short end (the bill-cash spread), it doesn’t see this continuing into its 2008 financial year, which starts October 1.

It said its lending rates on the business side are around 0.15%-0.20% as a result but this will take some take some time to fully flow through. The ANZ has also edged up some consumer rates, but nowhere near as many as the 0.30% lift by Adelaide Bank for its mortgages.

It also means that the prospects of non-bank lenders being crippled by the rate hike, such as the troubled Sydney-based Rams Home Loans Group is also easing.

This loosening of the credit lock up has seen the margin over the Reserve Bank’s cash rate of 6.50% closed markedly, but that in turn means the prospects of a further RBA rate rise have increased, given the continuing out-performance of the Australian economy.

According to Macquarie Bank economist, Rory Robertson the RBA is on hold, waiting to see the full extent of the market-based tightening of financial conditions, and waiting to see the Q3 CPI on 24 October in order to revise its inflation forecast.

Glenn Stevens, the Guv, said in his speech on Tuesday:

Hence it appears, at this stage at least, that we may well observe a further tightening of financial conditions in the Australian economy in the months ahead… Given the macroeconomic situation of the Australian economy thus far, some additional restraint would perhaps not be unwelcome. But just how much such restraint will occur as a result of a market tightening in credit conditions is not yet clear.

If that “additional restraint” is easing, the central bank will be confronted with that unfortunate choice it thought it had avoided earlier in the week: what to do if the September quarter’s Consumer Price Index is a poor figure?