More signs of a slowing economy with manufacturing activity contracting last month, but don’t expect the Reserve Bank to move quickly to cut interest rates, unless it is suddenly convinced the economy has fallen into a big black hole.

The Reserve Bank board meets in Sydney on Tuesday and is not expected to shift rates but governor Glenn Stevens will give us an update on current thinking in his after meeting statement.

The Australian Industry Group/PriceWaterhouseCoopers Performance of Manufacturing Index showed another month of contraction last month as the slowdown which started around January-March continued. The result of 46.9 was the lowest since late 2005, when the Index was on 43.7.

The RBA is likely to recognise the continued tightening and send a signal that a rate cut is moving closer, but the bank will still voice its reservations about moving too early, given the surge of export income now entering the economy and stubbornly high inflation.

The monthly TD Securities/Melbourne Institute Inflation gauge this morning revealed that consumer prices rose at an annual rate of 4.6% in June, down from the 4.8% annual rate in June. If maintained for the next couple of months, it could be a sign that inflation has peaked for the time being. For that reason the RBA is likely to wait until the next CPI numbers are released in late October and the most likely month for a cut is November.

But with global commodity prices experiencing their biggest fall in nearly 30 years in July, led by falling oil, wheat, corn, zinc and copper prices, pressure seems to be easing on inflation.

Corn and wheat prices in particular are now sharply lower than the worrying all time highs earlier in the year, while oil at $US124 a barrel, is now $US23 under the all time high set on July 11.

But the RBA is likely to wait and see if these falls continue into August and beyond.

July employment figures and June quarter House price Index figures are also out next week, as is housing finance figures for June; all of which will increase pressure on the bank to move rates sooner than it wants to.

TD Securities senior strategist Joshua Williamson has been forecasting a cut in December but now thinks the bank should consider bringing down rates even sooner.

AMP Capital chief economist Shane Oliver urged the bank to drop rates immediately to ease the consumer pain and steer the economy out of recession.

“The RBA went too far with its rate hikes. Nobody wants to see retail spending falling as quickly as this,” he said.

But economists at investment bank, Merrill Lynch don’t think we will get a rate cut soon. They say a rate cut won’t happen until early next year. But Merrill Lynch was one of the last groups in the market to concede that the slowing economy would offset the expected sharp rise in June quarter inflation and not caused a rate cut.

But the AMP’s Dr Oliver said that “while RBA Governor Glenn Stevens has indicated the Bank will not wait for inflation to return to target before easing, it may take a while for it to become comfortable to start cutting. We believe that cash rates will start heading lower later this year and by end 2009 the official cash rate will be back down to around 6%.”

And the realisation that Australian interest rates could fall because of the slumping domestic economy has seen the value of the Australian dollar drop more than two cents this week. The currency was trading around 93.77 US cents this morning, down from 95.84 at the close of local trading last Friday. This fall will go someway to offsetting the drop in the world oil and petrol price if it’s maintained for the next few weeks.

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Peter Fray
Peter Fray
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