The Reserve Bank cut interest rates by 1% to 4.25%, thus undoing all the tightening of the past six and a bit years and taking rates back to where they were in December 2001.

That loosening of monetary policy has taken just four board meetings, starting in September with a cautious 0.25%, then October’s surprise 1%, November’s equally surprising 0.75% and then today’s much forecast 1% cut. And given the speed of the collapse in global and local demand and output (in manufacturing, retailing and home building, plus what’s now happening in resources) there’s every chance rates could go lower — well under 4% and stay there for some time.

The bank didn’t talk about recession, but there’s a much stronger impression left from the statement that demand and output here have fallen a lot faster than expected, especially in the last two months. The global recession won’t be easing any time soon and we will continue to be affected, now that we have been dragged down by the slump overseas.

That’s the sort of message Opposition leader Malcolm Turnbull and his Treasury spokesman, Julie Bishop, should take from reading the RBA Governor’s latest statement.

The central bank left a hint in the statement that, in normal times, would have been taken as ending the spate of rate cuts:

Weighing up the international and domestic developments of recent months, the Board judged that a further significant reduction in the cash rate was warranted now, to take monetary policy to an expansionary setting.

As a result of today’s decision, the cash rate will be at its previous cyclical low point. Given trends in money market yields, most lending rates should fall significantly and will also reach below-average levels.

But these are not normal times: the RBA also pointed out that while Australia’s economy has been “more resilient than other advanced economies”, recent figures “suggested that a significant moderation of demand and activity has been occurring.”

The statement went on:

With confidence affected by the financial turbulence and a decline in the terms of trade now under way, more cautious behaviour by both households and businesses is likely to see private demand remain subdued in the near term.

With that outlook, and with capacity pressures now easing, it is likely 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 have been the case.

Together with the spending measures announced by the Government, and a large fall in the Australian dollar exchange rate, significant policy stimulus will be supporting demand over the year ahead.

Recent actions by governments and central banks to stabilise their respective financial systems have begun to take effect.

Nonetheless, financial market sentiment remains fragile, as evidence accumulates of weak economic conditions in the major countries and a significant slowing in many emerging countries. Commodity prices have fallen further. This, combined with the likelihood of below-trend growth in the global economy, suggests that global inflation will moderate significantly in 2009.

Macquarie Bank interest rate strategist, Rory Robertson (who forecast a 1% cut) said ahead of the release said:

Happily, the first 200bp worth of cash-rate cuts prompted major lenders to lower their standard variable mortgage rates by about 180bp, a “pass through” of about 90%. That’s a great result given the debate in July in which many analysts mistakenly argued that the pass-though into mortgage rates would be minimal.

If that 90% flow-on to mortgage rates continues after today’s big RBA cut, most homebuyers – both current and potential — will be facing rates in the 6-7% range before Christmas. The political focus probably then will shift towards the (much) slower trend to lower rates for small-business and credit-card borrowers.”

Robertson believes the RBA could continue cutting to well under 4%, perhaps as low as 3% next year and stay there “for a prolonged period” because economic conditions will be sluggish for quite a while.

Peter Fray

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