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Why the first rate cut is the hardest

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The Reserve Bank board meets today and the case is building for an interest rate cut and the pressure is too with the likes of union boss, Paul Howes, getting stuck into the Reserve Bank boss, Glenn Stevens.

AMP Capital Investors’ Shane Oliver takes a more sedate position, but is still at odds with the Big Bank, arguing that he doesn’t expect a rate cut today, but that there should be one before the year’s out.

Surprisingly, when I had our former prime minister John Howard on my Sky News Business Channel program, he wasn’t in the cutting camp at the moment, preferring to be an ‘on hold’ man while definitely opposed to a rate rise.

Regular readers know my position — we need a cut or two and we needed them a year ago but it’s now getting beyond a joke!

RBA’s inflation fears

In case you cannot understand Mr Stevens’ stubborn attitude, it’s linked to his fear that a big inflation surge will come from the China boom, its demand for our iron ore and coal, whose prices have gone sky high, the income that this export boom will bring and the expected massive business investment that will follow.

He talks about medium-term inflation concerns and while admitting the slow part of the two-speed economy is suffering, those are the breaks. I know it sounds heartless but that’s why economics is called the dismal science — there will be winners and losers.

However, it’s not a science. Economics is a social science and it’s more an art with a strong reliance on understanding the psychology of business, consumers and markets. 

Changing message

Until the global economy was marked down around July this year, the RBA had a much stronger economic outlook for both the world and Australia but with European debt problems and the fear of a US double-dip recession getting worse, the Bank’s messages have changed.

Formerly, the between-the-line warning was that two or three interest rate rises were on the way. But now the new message is that rates are on hold for a sustained period of time. That’s Mr Stevens’ concession for not getting his guesses on the local and global economies right. In addition, I don’t think he expected such a mess in Europe with the second-rate rescue plan for their indebted basket case economies. I don’t think he expected European banks to be so vulnerable to their debts to European governments and he wouldn’t have tipped that the USA would lose its Triple-A credit rating. 

Rates must fall

Basically the RBA’s crystal ball needs replacing and whoever buys this useful forecasting tool should give Westpac’s chief economist, Bill Evans, a call to see where he got his. Bill was the first banking economist to move into the “rates must fall” team and he, for one, isn’t worried about medium-term inflation anymore.

You know, I think the Yanks will avoid a recession but I think the Europeans will help to drag down world growth and that will take the heat out of our export boom. It will still be solid but a bit weaker than was expected and that’s a compelling reason for the Big Bank to cut rates. 

Data watch

But even more important for the ‘rates must fall’ argument is the weakness of the economy right here, right now.

Have a look at these numbers:

  • Inflation adjusted weekly disposable household income fell for the first time in 14 years.
  • Private sector building approvals for new homes are at a 28-month low.
  • New home sales are at a 10-year low.
  • The Wall Street Journal two weeks ago was predicting a home price slump in Australia.
  • Wage rises in the June quarter were the weakest result in 18 months.
  • Unemployment rose from 4.9 per cent to 5.1 per cent in July but in Victoria the jump was from 4.6 per cent to 5.1 per cent!
  • Retail trade rose by a small 2.6 per cent in 2010-11 making it the weakest annual growth in 50 years.
  • Consumer confidence is at a two-year low.
  • Business confidence recently had a small rise but it was off six-month lows.
  • The last reading we had on the growth of the economy was -1.2 per cent for the March quarter compared with the same quarter last year.

You don’t have to be an economist to work out that this is a weak economy in need of a shot in the arm — even the butt would do! — before it’s too late.

Recently, national icon and business builder, Gerry Harvey of Harvey Norman argued that with unemployment where it is and the resources boom happening, we should be as “happy as pigs in shit” but his August sales have been poor. 

Right or wrong?

Glenn Stevens might end up being right but at the moment he looks terribly wrong and a lot of people are set to suffer with more and more big companies talking about cost-savings which means job losses and less work for contractors.

All of this will compound onto small business and unemployment will rise. Sure the miners will keep creating jobs but it might not help those who don’t want to don a miner’s helmet and live at the back of nowhere.

I really hope Glenn’s guesswork is spot on, because if it’s not, he will be held responsible. I know the first rate cut is the hardest for a central bank boss but that’s all we might need to turn around confidence.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Tuesday, September 06, 2011

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