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Interest rates set to fall

The news out of Beijing might not have been as bright as we sports nuts Aussies might have liked, but our personal economic fortunes might be starting to head for gold.

Last week I was tongue-lashed by a well-known rugby league player’s agent who, after he’d had a tired and emotional afternoon in a local watering hole, pleaded for me to come up with some good economic news.

So, here goes.

After months of ordinary economic headlines it is now certain that the Reserve Bank will cut interest rates next month. It’s about as certain as the All Blacks winning at home and choking in the World Cup.

After the cut

The end-result of rates cuts will be the resumption of good economic growth. Only this week, forecaster BIS Shrapnel rubbed its crystal ball and this is what it saw:

“BIS Shrapnel forecasts a return to strong economic growth in the medium term, once the current episode of ‘overdone pessimism’ has receded.

“This growth will be driven in part by lower interest rates over the next year, although inflationary pressures from capacity constraints and labour markets will prevent interest rates from falling back to the low levels seen earlier this decade.”

The banks will fall in line

Okay, you might be saying, but what about the banks? Will they pass on the cut? The answer is ‘yes’. This looks more likely as you hear the rhetoric from Messrs Rudd and Swan out of Canberra and you listen to the more conciliatory language from the bank bosses.

To date, NAB and ANZ have signed up to pass on the cuts and the others will be pressured to follow suit.
But will they pass it on in full?

That could be the debateable bit but Reserve Bank ‘Deep Throats’ say if the banks foil the Reserve Bank’s goal to cut rates by a certain amount, then it would keep reducing the cash rate.

How low could they go?
But wait, there’s more good news.
This week NAB’s chief economist talking on Sky Business speculated about how low interest rates could go.

He said the cash rate moving from the current level of 7.25 to six per cent would still mean the interest rate policy would still be tight. That means it would still be working to contract the economy.

Even with a cash rate of five per cent, Oster said monetary policy would be neutral. This means over the next 12-18 months, home loan rates could fall from around 9.5 to 6-7 per cent.

I suspect seven per cent-plus rates of interest will be more likely than six per cent plusm but if a recession turns up then I would change my guess!
Loosen the noose

That is good news for many Aussies feeling the interest rate noose tightening around their necks or maybe just their hip pockets.

Sure, this good rate cut news is because of the slowdown of the economy, which threatens pushing us into a recession, but we can’t change the past. We can alter the future and the Reserve Bank cuts in coming months will be critical.

The downward pattern

Many economists think we will see a 0.25 per cent cut in September followed by another in October. Others think we could see a 0.5 per cent cut first.

An important point to make is that if the banks don’t cut rates, they could turn the current economic slowdown in to a full-blown recession. This will affect the banks’ level of deposits as people lose jobs and businesses go broke. It would KO demand for loans and it would go straight to the banks’ bottom lines and share price.

The state of the economy

The most recent Sensis Business Index survey found business is starting to react to the slowdown and this will be another reason why the Reserve Bank will cut interest rates.

The survey found more than one in five small businesses have responded by reducing business costs. And just over 10% have responded by decreasing employment.

The latter is not good news but will force those in charge of interest rates to get with the program to cut rates.
China and India are props

In the background the strength of China and India as well as other emerging economies will help prevent a global recession, with the European economy slowing faster than was expected.

The Yanks are expected to recover first because they slowed down first and the combined story explains why commodity prices, including oil, have fallen recently.

All of this will help bring inflation down which is another reason why the Reserve Bank will cut interest rates.
Worst is behind us

This double-barrelled story also explains why the Oz dollar is falling. Not only is the US dollar rising as the worst of the stock market crash looks to be behind us but two reasons why our currency was so high were — high interest rates and high commodity prices.

But wait, there’s more still.
While car sales fell last month, buying a car is the easiest it has been for 24 years.
It now takes an Aussie only 31.8 weeks to buy a Ford Falcon XT while five years ago it would have taken 38 weeks.
Who said economists can’t do good news? It could be the financial planner inside of me that is better at finding good news.

Published on: Thursday, August 28, 2008

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