Interest rates are heading lower: not just yet, but possibly as soon as September. If it does, it would be the first cut after seven years of gradual tightening.

There was no change in official interest rates this afternoon, with the Reserve Bank revealing that it had left the cash rate unchanged at 7.25%, but the central bank sent a huge hint that a rate cut is coming.

The RBA said inflation will drop below 3% “during 2010” after being more equivocal in its July statement when it said “Looking further ahead, inflation in both CPI and underlying terms should decline over time, provided demand continues to evolve as expected”.

But in its latest statement today the bank indicated that “it is looking more likely that demand will remain subdued, and economic growth will be fairly slow, over the period ahead.”

For that reason, the RBA is more confident about inflation will fall over the next two years. In fact with oil prices down and the way economies seem to have peaked around the world, there’s every chance the inflation cycled peaked a in the June quarter.

That growing confidence about falling inflation, plus the sharp slump in domestic economic activity produced the significant change of heart in today’s statement from RBA Governor, Glenn Stevens.

Weighing up the available domestic and international information, the Board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.

The change of approach came a year to the day after the RBA began the final round of four rate rises, which, incidentally, was just two days before the credit crunch broke over world markets.

Since then those four rate rises plus the surge in oil prices and non official rates caused by the crunch have slashed demand in Australia and many other economies. Here, retail sales and building approvals are now flat to negative, compared to a year ago.

Figures were released today showing that car sales fell in July, but are still 2.6% ahead of where they were a year ago, despite the record level of petrol and oil prices.

But commodity prices are now falling. July saw oil prices peak at over $US147 a barrel, and then help pull all commodity prices down by the largest amount in 28 years; that’s a fall that has continued this month with another sharp decline Monday night and today. Oil was trading at a three month low of just over $US120.30 a barrel this afternoon.

That has pushed Australian sharemarkets down to a two year low this morning, and the Australian dollar down to a new three month low. The Aussie dollar weakened to 92.50 US cents after the RBA decision was announced, a new 12 week low.

We will get another sighter on the state of the economy with the July employment figures due out late Thursday morning.

Macquarie Bank interest rate economist Rory Robertson said before the RBA decision was announced that if the bank didn’t cut today, it would cut in September.

“My thinking is that if the RBA doesn’t cut today, then it very likely will cut next month. The RBA is set to respond to the fact that extremely tight financial conditions are bringing the Australian economy to a screeching halt.”

Treasurer Swan today said that it is “utterly irresponsible to speculate” about recession. Yet it is the RBA’s worry about the growing risk of recession that will drive its first cash-rate cut in seven years.

“The RBA’s initial cut – whether today or next month – should be read as an acknowledgement of the growing risk of recession, driven by financial conditions that have tightened more than the RBA ever planned or anticipated (via market-driven interest-rate “top ups” and a sharp tightening of lenders’ credit standards).”

Read the full RBA media release below


MEDIA RELEASE
No: 2008-12
Date: 5 August 2008
Embargo: For Immediate Release

STATEMENT BY GLENN STEVENS, GOVERNOR
MONETARY POLICY

At its meeting today, the Board decided to leave the cash rate unchanged at 7.25 per cent.

Inflation in Australia has been high over the past year in an environment of limited spare capacity and earlier strong growth in demand. This was evident again in the most recent CPI data. In these circumstances, the Board has been seeking to restrain demand in order to reduce inflation over time.

As a result of increases in the cash rate last year and early this year, additional rises in market interest rates and tougher credit standards, there has been a substantial tightening in financial conditions since the middle of 2007. Some further tightening has occurred over the past couple of months. Conditions in international financial markets remain difficult, with heightened concerns over credit persisting.

The evidence is that the tightening in financial conditions, in conjunction with other factors including rising fuel costs, and lower asset values, has restrained demand. Indicators of household spending have continued to record subdued outcomes over recent months, and credit expansion to both households and businesses has slowed significantly. Surveys suggest a softening in business activity, and there have also been some early signs of an easing in labour market conditions.

The rise in Australia’s terms of trade that is currently occurring is working in the opposite direction, adding substantially to national income and ability to spend. At the same time, high prices of oil and a range of other commodities have added to global inflationary risks. They are also dampening growth in a number of countries.

Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation. On balance, however, it is looking more likely that demand will remain subdued, and economic growth will be fairly slow, over the period ahead. Inflation is likely to remain relatively high in the short term, with the CPI affected by high global oil prices. Looking further ahead, inflation in both CPI and underlying terms is likely to decline over time, given the outlook for demand, provided wages growth remains moderate. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.

Weighing up the available domestic and international information, the Board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.


By Glenn Dyer

Oil prices led commodities lower overnight, continuing the trend established in late July as markets became more convinced that global economic activity will continue to fall.

The fall in oil and copper in particular, knocked the local market sharply lower this morning, with the ASX 200 and All ordinaries down more than 100 points just after noon, or over 2%.

Both indexes hit new two year lows during trading before noon. The Australian dollar sold off to hit a new three month low of 92.63 US cents on the lower commodity prices and the Reserve Bank board meeting could see a clear indication on a near term cut in interest rates.

Despite hopes for a rebound either next year or in early 2010, there are more signs that the combination of the credit crunch, the US recession, the surge in commodity prices led by oil in the first half of the year and then the dramatic acceleration in inflation, has drained major economies of their growth.

But the sharp fall in commodity prices holds out the hope of an easing in inflationary pressures later in the year and in early 2009. That will be the hope as the Reserve Bank leads off a busy week for central banks with a meeting today that won’t cut local rates, but will signal a possible easing in the next few months.

Goldman Sachs JBWere said in a client note today that it still expects a rate cut in November after yesterday’s house price index figures for the June quarter.

The tightest financial conditions since the last recession have a stranglehold on the economy. Consistent with a sustained severe slump in confidence, recessionary conditions are now simultaneously evident in the retail, manufacturing, house construction sectors. Today’s report highlights the inevitable transmission of this slowdown to property prices, and adds to the growing pressure on the RBA to make policy more accommodative.

We expect the first rate cut to come in November, with RBA commentary likely to become increasingly market-friendly in the interim.

The US Federal Reserve meets tonight and there won’t be a rate change when its decision is revealed at 4.15am Australian time Wednesday. The Bank of England and the European Central Banks’ decisions will emerge early Friday morning our time, with no change expected, despite the sharp fall in commodity prices since mid July.

Oil prices peaked at over $US147 a barrel on July 11, and are now around 17% to 18% below that level after the sharp fall overnight. Oil prices fell under $US120 for the first time in three months (it hit a low of $US119.50), before recovering to around $US121 as a hurricane missed oil and gas fields in the Gulf of Mexico.

But grains, including wheat and corn, fell heavily, as did soybeans, sugar, cocoa (off nearly 10%), cattle and copper, which dropped more than 4% at one stage, before settling down 13.6 cents at $US3.44 a pound in New York. Copper’ closed at a six month low as stocks rose, a sign that even the still solid Chinese economy has enough metal.

The plunging copper, oil and other metal prices will make a mess of Australian resource stocks today, with BHP Billiton and Rio Tinto expected to lead the market lower after Wall Street joined Asia and Europe in falling.

But inflation isn’t going away soon, which will keep central bank hands off the interest rate cut lever. There was more evidence of rising inflationary pressures in Europe and the US overnight. In the US, the Fed’s favourite inflation index, the so-called core personal consumption expenditure index – rose by 0.3% in June, more than expected and on an annual basis its up 2.3%, above the Fed’s target range of 1%-2%.

In the so-called eurozone (the group of countries using the euro as their currency) producer price inflation jumped to an annual rate of 8% in June from 7.1% in May. With July’s big price surge (up to the middle of the month) still to be accounted for, another rise is expected next month. The eurozone producer price rate is now approaching the 9%-10% rate for the same gauge in the UK and US.

Peter Fray

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