Fears that the economic slum is coming faster than thought has forced the Reserve Bank into making another larger than expected rate cut for a second month in row.  The bank this afternoon slashed interest rates by 0.75%, to take its cuts since its September meeting to 2%, the quickest and fastest rate cuts in its history. The last time the RBA cut rates as quickly was in February-April of 2001 when it chopped the cash rate by 1.50%.  But nothing like a sequence of 0.25% in September, 1% last month and 0.75% today. At 5.25%, the cash rate is the lowest since late 2003. It’s a sign that the central bank has become very concerned that the economy is sliding quickly into recession next year, as the likes of Goldman Sachs JBWere, JPMorgan and a growing number of other forecasters are saying.  It’s now saying that spending and activity in the economy will be “weaker than earlier expected’. Instead of worrying that the improving terms of trade will push too much money into the economy, falling international demand and commodity prices will now have a “dampening influence” on the domestic economy. Yesterday’s weaker than expected house price index figures, showing a the biggest fall for decades, a sharp fall in retail sales, manufacturing and job ads in October, all point to the level of activity in the economy slowing at a rate much faster than previously thought. The fact that the bank cut rates 0.75% to 5.25%, is a sign that it now seems growth slumping. And another rate cut is on the cards next month as a result and the bank could cut the cash rate under 5%, especially if the September guarter’s growth figures are bad, when released at the end of this month.  Unlike last month when it in part justified the surprise 1% cut on forcing as much of the rate cut through to borrowers, they were not mentioned in today’s statement accompanying the decision by Reserve Bank Governor, Glenn Stevens. The bank merely pointed to “recent reductions in borrowing rates” working with the impact of the weaker dollar and the Federal Government’s stimulation package to “assist growth in the period ahead.”  The bank had forecast in the August Monetary Policy Statement that non farm GDP would dip to 1.5% annual this quarter before edging up to be running at around 2% in the second half of 2009. (The RBA updates Monetary Policy next Monday with the latest quarterly statement.) The bank seems to be warning that the slowdown in economic growth is almost upon us: previously it has been looking for growth to dip in the first half of next year and continue at low levels into the second half. “Recent reductions in borrowing rates, the depreciation of the exchange rate and the fiscal stimulus announced in October will work to assist growth in the period ahead, but deteriorating international conditions and falling commodity prices will have a dampening influence.  “On balance, it appears likely that spending and activity will be weaker than earlier expected. “In Australia, the overall path of economic activity appears until recently to have been close to what the Board had expected, with a needed moderation in demand occurring after a period of earlier strength. International economic data have continued to point to significant weakness in the major industrial economies, and there have been further signs that China and other parts of the developing world are slowing as well. These conditions have contributed to further falls in world commodity prices.

“Consumer price inflation in Australia remained high in the September quarter. As expected, CPI inflation in year‑ended terms picked up to 5 per cent, while underlying measures were just over 4½ per cent.

“Nonetheless, capacity pressures are now easing and, given the outlook for more moderate growth in demand and activity, it is reasonable to expect that inflation in Australia will soon start to fall. Global disinflationary forces will assist in this regard, though the depreciation of the exchange rate means that the decline of inflation to the target could take longer than would otherwise be the case.

“Weighing up these international and domestic developments, the Board judged that a further significant reduction in the cash rate was warranted. The Board will continue to monitor developments and make adjustments as needed to promote sustainable growth consistent with achieving the 2–3 per cent inflation target over time.”

Read Alan Kohler’s take at Business Spectator.

Peter Fray

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