RBA rate cut – 25 or 50 points.

June 5, 2012

RBA and Interest Rates

I think by now its clear that the RBA went 50 basis points last month because it knew that the economy needed some monetary stimulus but equally that the Banks were going to hold some back. The Majors were actually more generous in passing on a big proportion of the cuts than some of the smaller players who dragged back a big lift to NIM and in the process blurred their value proposition with their constituency.

But I also think its clear that the Australian economy and more crucially the global economy has taken another leg lower over the past month. Europe is clearly sliding toward recession, the US recovery is spluttering to say the least. Non-farm payrolls released Friday were terrible> LAst night we saw the collapse of the New York ISM which printed at 49.9 from 61.2 last month, factory orders in April undershot expectations of a rise of 0.2% to post a fall of 0.6% and if we abstract transports the fall was greater than 1%.

And then of course we have the European malaise with S&P saying that there is a 1/3 chance of Greece leaving the Euro, Spain’s failed/aborted/unaffordable rescue of Bankia has morphed into fears about the next Domino to drop and I see overnight that Reuters reported that 3 Portuguese Banks are seeking funds for a bailout. All the while the germans, lead by Angela Merkel, seem to have lost none of their Teutonic intransigence.

Tonight there is a G7 hook-up which appears like an Obama administration attempt to press-gang the Europeans to get their act together. The fact that these usually clandestine meetings have been publicised shows the politics of the situation is as important as the actual outcome to the players. Obama wants to be seen to do something but it seems trying to bully Germany might not be the most insightful strategy to follow.

So when the Reserve Bank Board sits down around the table at Martin Place this morning the mood is likely to be dark with a strong focus on the risks to the economy. They will be happy that the Australian dollar is lower – the Aussie was 1.0430 when they sat down on May 1st and it is now sitting at 0.9727 for a fall of 6.74% over the month and a loosening of Monetary Conditions in the economy. This is important in the context of the justification for the big 50 basis cut last month when they said,

In considering the appropriate size of adjustment to the cash rate at today’s meeting, the Board judged it desirable that financial conditions now be easier than those which had prevailed in December.

So there is little doubt that with the cash rate lower, with borrowing rates lower, with the currency lower and with Government bond and swap rates also low, very low by historical standards monetary conditions in the economy are more expansionary.

But mortgage rates are still not that far below average as Banks have rebuilt their margin and the outlook for the global economy is more uncertain now than at any time since Lehman collapsed in September 2008.

So I find it hard to see that some of the pundits reckon the RBA will leave rates on hold – 25 years in this game have told me to never say never but that seems the least obvious outcome given the National and Global economic and market backdrop. But will they go 50 basis points instead of the almost locked and loaded 25?

My sense is that this would be unlikely because while there has been a deterioration in the global backdrop and Europe remains a clear and present danger two 50 point cuts in a row might worry people, families, investors and the like more than it will assuage their fears. Economics is always a confidence game and it seems to me that the RBA will try to chart its usual steady course but be prepared to act aggressively, as it did in 2008, should things blow up again.

Ultimately though I think the RBA cash rate will head down toward 2.50% as Australian and global growth stalls further.

Have a great day

Gregory McKenna

www.twitter.com/gregorymckenna

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If however you do need advice on Investments, Economics, Funding and Liquidity, Interest Rates and Forex and Derivative markets we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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