RBA to keep cutting rates

The case for another rate cut next month continues to build as the outlook for the Australian economy worsens. Research released this week by a major bank and the Melbourne Institute found that Australia’s economic growth is likely to slow even further as demand weakens and credit conditions remain tight.

The survey looked at expected Australian economic activity over the next three to six months and overall painted a grim picture. It found that the annualised pace of economic activity slowed to 2.5 per cent in August which is its weakest level in six years. This is the third month in a row that the reading has been below the long-term trend of 4 per cent.

Other data released this week showed that businesses and households were reluctant to borrow during August. Lending finance data showed that credit growth has steadily fallen as borrowers have reined in spending and tightened their belts.

In the near term, the RBA Board will continue to look for signs of major deterioration in domestic spending and business investment. Tighter credit conditions and softer terms of trade are likely to put a serious dent in future business expansion and employment plans. Mining giant RIO Tinto for example, indicated this week that it was reviewing the timing and cost of its short-term capital expenditure program.

The key issue that will continue to dominate the market is the risk that the current global financial market turmoil will spark a recession in Australia. Although Reserve Bank Governor Glenn Stevens slashed 100 basis points off the official cash rate last week in an attempt to restore liquidity in the Australian banking system, the bulk of the market is betting that the official cash rate will have to be lowered even further.

The RBA is likely to cut the cash rate from its current level of 6 per cent to less than 5 per cent by early January 2009. Commentators are predicting that the RBA Board will recommend a 50 point basis cut in November and again in December. These moves to ease monetary policy are preventative measures to stop the Australian economy from grinding to a halt.