The National Australia Bank says the Reserve Bank will cut by half a per cent next Tuesday because of the worsening of the global financial crisis.

In a note issued today, the bank’s head of economics, Alan Oster, said there was now a need for the RBA to be “more aggressive” in its rate cutting because of the global turmoil. Such a cut would come despite the passing this weekend of the US bailout package, also known as the TARP.

We see the RBA as needing to cut more aggressively than we previously expected. Accordingly, even assuming the passage of TARP, it would require a 50 point adjustment next week for the RBA to have any significant impact on the lending rates that banks set for their customers.

Our judgment is that the RBA will also follow up that adjustment with another before year end (most likely November – where we have now pencilled in another 25 points). Thereafter, we see a series of rate cuts bringing the cash rate down to 5.5 percent (previously 6 per cent) by April 2009.

In making the call, he joins Macquarie Bank interest rate strategist, Rory Robertson, who again forecast late yesterday the RBA could very well cut by half a per cent on Tuesday.

Against that background of a further sharp deterioration in global economic circumstances, the RBA looks set on Tuesday to cut its cash rate by 50bp to 6.5%.

And, as observed here previously, if the global credit crunch continues to intensify, and domestic growth continues to downshift as commodity prices continue to fall, the RBA’s six-plus-years worth of monetary tightening – lifting the cash rate from 4.25% to 7.25% between May 2002 to March 2008 – may end up being unwound in just a year or two.

But economists at Goldman Sachs JBWere think otherwise and are forecasting a 0.25% cut next Tuesday.

Our central view remains that the RBA will cut rates by only 25bp next Tuesday…Assuming a 25bp rate cut this month, we continue to expect another 25bp rate cut in December and a further 75bp of easing in 2009.

And, looking at the global economy, Mr Oster says the risks had risen for a hard landing.

We are clearly also operating in an environment where the risk of a very hard global landing has risen – to say 30 per cent. In some areas – such as the UK and Europe – we see central banks moving earlier than previously expected. In other areas, if growth deteriorates more than expected, central banks may be forced to do more (USA).” Mr Oster warned.

While it now looks as if the US Congress will finally approve the TARP package it needs to be remembered that the package is not a “silver bullet”. Yes it may help prevent further financial contagion but it will not prevent the USA, Europe, UK and Japan moving into moderate recession in 2009 – with the trough in growth probably not reached until early / mid 2009.

That very much reflects the lagged impact of weaker house and equity markets, still high commodity prices (especially oil), deteriorating business and consumer confidence and credit rationing.

At this stage, however, we are still of the view that global growth will be around 2½ per cent in 2009 – albeit nearly all of that growth coming from the developing world. That, of course, assumes the TARP succeeds in calming the current turmoil in global financial markets and, in particular, allows for an orderly recapitalisation of the impaired global banking systems.

However, Mr Oster cautioned that “Much depends on avoiding further global contagion in coming months. Wee see the risks to both growth and interest rates as being to the downside. Here it is worth noting that official cash rates of this order in Australia, are still on the tight side and could well go lower depending on the growth outlook and the speed with which financial markets return to more normal settings.”

Peter Fray

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