Greenspan and RBA signal more rate cuts

Borrowers on variable rates can look forward to more interest rate falls this year on the strength of statements by Australian and US monetary authorities in recent days.

Most of the time interest-rate watchers spend their time trying to guess what's in the mind of the powers that be in central banks. This week is one of those times where we actually get to know.

Last night's parliamentary testimony by US Federal Reserve chairman Alan Greenspan combined with the Reserve Bank of Australia's monetary policy statement on Monday shed much light on where the rate-setters think the economy is going in 2001 and what their rates decisions might be in response.

Significant in the RBA statement was the emphasis on the US slowdown and its importance to our own outlook. The RBA says we are well-placed currently for a soft-landing based on our own economic fundamentals.While domestic demand has moderated and growth is slowing, inflation “remains well contained”, wage growth is moderate, healthy profit levels are largely maintained while our low dollar leaves us more competitive internationally.

These are the ingredients for a soft landing. But the big question mark over this scenario according to the RBA comes from across the Pacific – the strength of the US slide will largely determine the extent of our own performance this year.

On this note, Greenspan's tone was more optimistic than might have been expected amid recent fears that the US economy was grinding to a halt. While the US economic growth virtually stopped in the last quarter of 2000, Greenspan sees “an implicit strengthening of activity after the current rebalancing is over, although … forecasts for real GDP still show a substantial slowdown, on balance, for the year as a whole.” More specifically, it seems the economic indicators have not been quite as bad in January as they were in December and growth is expected to pick up soon, he said.

A key point raised by Greenspan applies to Australia, too – that consumer confidence is a key variable at times of economic vulnerability and can make the difference between a recession and a soft landing. Of the US, he says: “Although consumer confidence has fallen, at least for now it remains at a level that in the past was consistent with economic growth.”

The same appears true here; there is no sign yet of consumer confidence collapsing to an extent that threatens a spiral into recession. Today's Westpac/Melbourne Institute survey of consumer confidence shows a rise this month of 0.6 per cent to 102.1, the second rise in three months. A 100+ result suggests overall confidence rather than a lack of confidence.

If people remain confident enough to keep spending, one of the most important underpinnings of the economic health remains in place and a soft landing can be achieved in Australia and the US.

All in all, it appears that both the RBA and the US Federal Reserve stand ready to cut rates further in order to fine tune to this outcome. This means perhaps another 0.5 to 0.75 percentage points if they are successful, but more if they are not and the US slides into recession dragging Australia down with it.