RBA slashes rates by 1 per cent

The Reserve Bank took the market completely by surprise this week by slashing the official cash rate by 100 basis points to 6.0 per cent. This represents the largest rate cut in 16 years and has lowered the cash rate back down to where it was in November 2006.

Governor Glenn Stevens’s aggressive move shows just how nervous the Bank is about the risk of the Australian economy slipping into recession. As a result of the current maelstrom in global financial markets, the Bank now believes "that a material change to the balance of risks surrounding the outlook has occurred, requiring a less restrictive stance of monetary policy…The Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers."

The RBA’s attention has moved past inflation to reducing funding pressures for banks. The Reserve Bank is focused on easing credit conditions so that it’s easier for local banks to lend to households and businesses. In the RBA’s statement this week, the Bank confirmed that inflation is likely to fall much faster than previously thought and as a result, it is likely to lower its inflation forecasts in its next economic review, out next month.

More rate cuts are highly likely, although the Bank has signalled that another big one-off cut is unlikely. In earlier statements, the RBA has reported that its neutral official cash rate, where economic activity is neither stimulated nor slowed, is between 5.5 – 6 per cent. Given the higher cost of bank funding, the neutral cash rate is now likely to be at least 50 basis points lower, in the 4.75 to 5 per cent range.

As a result, the market is expecting the Bank to keep cutting the official cash rate over the next six months, and commentators are predicting cuts of at least another 100 basis points, eventually lowering the cash rate to around 5 per cent. Some pundits are predicting another 50 basis point cut before Christmas.

Infochoice.com.au