Rate-cut expectations growing

Fears about deflation in the US have seen market sentiment on interest rates fall further in recent weeks. However, there is virtually no prospect of the Reserve Bank cutting interest rates at its June meeting on Tuesday.

But bond yields have dropped and this is dragging fixed home loan rates well below standard variable rates. It also has some financial market analysts saying the Reserve Bank may cut official interest rates by the end of the year with the bond market currently pricing in rate cuts of 0.25 to 0.50 percentage points.

Britain, Sweden, New Zealand, the US and the European Central Bank may all consider cutting rates next month but the economies of these countries are not as healthy as Australia's.

US Federal Reserve Chairman Alan Greenspan has so far said the threat of deflation is not great. Fears may ease in coming weeks after this current bout of nervousness, especially given the latest rise in economic confidence and home sales in the US, which may put a floor under interest rates.

If this happens, the local bond market may shed its bearish pointers to lower variable rates here. But if more bad news emerges, the pessimism in the US will likely strengthen and the rate-cut chances here will grow.