While there’s an emerging consensus that the Reserve Bank will not only cut interest rates after its September 2 meeting, but cut by 0.50%, I’d be keeping a close eye on the sliding Australian dollar.

As world oil prices have sunk below $US120 a barrel since July 11’s peak of $US147.27, the Aussie dollar has fallen from its peak of just over 98 US cents to a soft 91.60 US cents this morning. All thought of parity by Christmas has gone as have some of the gains from the sinking oil price: the Aussie is now off 7% in just over three weeks, a substantial fall.

The Aussie’s fall will be accelerated by the RBA’s rate cuts, so at some stage hopes for rate cuts of up to 1.25% could be truncated, if the currency falls too quickly under 90 US cents.

A cut of 0.50% would have the added benefit of putting enormous pressure on the banks to give back some of their extra rate rises. Some analysts question whether the banks will move, arguing their funding costs remain elevated, but that’s a load of hooey.

The banks have loaded between 0.50% and around 0.60% on top of what the 1% increases the bank has made in the past year, so with that falling trend in the market they could cut.

Many commentators and especially politicians have ignored those extra bank rate rises in complaining about what the RBA was doing, or claiming that the banks’ move to lift rates in February and March was “too much”. Only one economist to my knowledge voiced such a criticism at the time — AMP’s chief economist, Dr Shane Oliver.

Macquarie Bank interest rate strategist Rory Robertson said last night a rate cut was a “given” and raised the possibility of a cut of up to 0.50%. He said we could get up to 1.25% in cuts (which would see the cash rate down to 6%) by the end of next year.

The National Australia Bank’s Alan Oster said that after yesterday’s RBA statement “we now expect the RBA to cut rates by at least 50bp by the end of 2008” and 1.25% by the end of 2009.” He continued:

Over the past month we have become worried about how quickly the evidence of the slowdown has been accumulating and how broadly the slowdown has become evident across the range of economic indicators. Not the least of these has been the sharp deterioration in Business Conditions and plummeting Business Confidence, as revealed in our June Quarter Business Survey released last week.

Goldman Sachs JBWere wrote this morning:

Once the RBA moves to such an explicit easing bias it rarely keeps the market waiting. We now expect the RBA to ease 25bp in September and to follow through with a second cut of 25bp by December. Speculation will now swing to the possibility of a 50bp cut in September. It is worth noting that in each of the easing cycles since 1990 the RBA has commenced the cycle with at least a 50bp cut. We expect additional rate cuts at the February 2009, August 2009 and November 2009 for a total of 125bp of easing by December 2009.

And UBS said in its note:

We now expect a 25bp cut in September 2008, and again in November as the Q3 inflation prints favourably (UBS estimate: 0.6% & 0.8% for core). This would be a more cautious start than previous rate cycles, which we believe reflects greater current inflation pressures and the likely positive stimulus from the terms of trade & recent tax cuts, but acknowledges the risks to the economy emerging in the quickly weakening consumer and housing sectors.

None mentioned the weakening dollar. If it continues to lose ground in the next month, and especially after the September 2 meeting, that will change.

Peter Fray

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