Rate-cut mood returns after US drop

Hopes for further imminent cuts to interest rates in Australia lifted with the surprise Federal Reserve decision this week to shave another half a percentage point from US rates in a further effort to stimulate weakening economic activity.

The US cut gives Australia's Reserve Bank more room to move in cutting variable rates, as well as more reason. It signals that American monetary authorities hold serious concerns about falling economic activity – and US conditions are a key factor cited by the RBA for our own economic fortunes this year.

The US cut has brought predictions of an unprecendented fourth successive rate cut here in May, likely 0.25 this time. Important for the RBA decision will be CPI figures for the March quarter out on Tuesday showing just what inflation pressures exist this year – very little, quite likely.

The move has also changed market expectations about the direction of fixed rates and where the bottom of the interest rate cycle lies. Last week fixed rates edged up as expectations grew that the end of the rate cutting cycle was near. Now that sentiment has reversed. Falling yields in the bond market have yet to flow through to fixed loan rates but we may see them edging downward again next week, especially shorter term rates.

The danger from the rapid and sizeable reductions in official rates we've now seen is that the seeds may now be being sown for an unsustainable burst of economic activity next year. The lowest rates in almost three decades in the US are now in place despite the jury still being out on just how strong the current downturn is. We may see rates having to move up next year almost as quickly as they have come down this year.