Press release - 10th October 2008
Stunning rate cut to shore up economy
Reserve Bank Board meeting
- The Reserve Bank on Tuesday cut the cash rate by 100 basis points (one percentage point) – the biggest reduction in more than 16 years (since July 1992). The cash rate now stands at two-year low of 6.00 per cent.
- Investors will need to re-assess current strategy with property the clear winner from today’s stunning rate cut. CommSec believes that investors should maintain the current defensive posture on sharemarket investment given on-going global risks, but investors should be alert for bargains.
What does it all mean?
- Decisive and courageous – not words that you normally associate with the Reserve Bank but entirely appropriate. These are desperate times, requiring desperate measures, and the Reserve Bank hasn’t been afraid to act. No doubt the Reserve Bank felt it couldn’t rely on other central banks and regulatory authorities to take decisive action to shore up their economies – it had to take up the cudgels itself.
- There’s a time to worry about inflation, but now isn’t one of them. With a global recession a 50:50 proposition, and commodity prices falling across the board, risks have now shifted in favour of deflation, not inflation. Today’s rate cut is not only appropriate in the current environment, it’s entirely prudent in order to extend the length of our record-breaking economic expansion.
- Ordinary Australians can be thankful that we have both a responsive and responsible central bank in the form of the Reserve Bank as well as a strong banking system. Australian banks are recording profits, not losses, and looking at making acquisitions, rather than being acquisition targets. The Reserve Bank has given the banks plenty of elbow room to cut rates so the stimulus flows through to the wider economy.
- Finally home borrowers have a reason to celebrate. And there may be even more good news down the track. A cash rate of 6 per cent still constitutes restrictive monetary policy. It is only when the cash rate gets to 5 per cent or below that the Reserve Bank is again pressing on the accelerator rather than the brakes.
- Today the Reserve Bank has removed the rate hikes delivered in November last year and February this year together with the rate increases delivered by the major banks over 2008.
- The Reserve Bank has clearly front-loaded its rate-cutting cycle in order to address negative psychology and deliver significant stimulus to the economy. The Reserve Bank rightly believed that shock treatment was necessary to change the mood and momentum of the economy.
- When a central bank cuts rates by such a large amount, the question is whether it knows something we don’t. The Reserve Bank may very well be spooked, but not by the domestic economy, but rather the US and Europe. This may be the start of co-ordinated central bank rate action. Hopefully it will be.
Interest rate decision and past cycles
- The Reserve Bank has cut the official cash rate by 100 basis points (one percentage point) to 6.00 per cent. This was the biggest rate cut since July 1992 and follows the 25bp decline on September 2. The cash rate now stands at 6.00 per cent – the lowest since August 2006.
- Before the September rate cut there had been twelve rate hikes in the cycle extending back over five years (since May 2002), the last occurring on March 4. Over that period, rates lifted 2.75 percentage points to 7.25 per cent.
- Just like 2000/01 there was a gap of six months between the last rate hike and first rate cut. In the 2001 rate cut cycle, rates were cut by 2 percentage points in the space of 11 months (to 4.25 per cent).
- In the prior 1996/97 rate cut cycle, cash rates were cut 2.5 percentage points in 12 months, followed by another 25 basis point move just over 16 months later. The low point for interest rates was 4.75 per cent.
Reaction: Sharemarket lifts; AUD falls, then recovers
- Sharemarket investors celebrated the news of a substantial rate cut by pushing key indices higher. The ASX 200 jumped 100 points in reaction to the rate cut announcement before putting on another 35points. The ASX 200 was down 3 per cent earlier in the day, but was up over 2 per cent in the last hour of trade.
- The Australian dollar fell from US72 cents to US70.38c, before rebounding to US73.20c in afternoon trade.
- Bank bill futures are now pricing in a cash rate of 5 per cent by March 2009.
- Westpac has cut is variable housing rate by 80 basis points.
What are the implications for interest rates and investors?
- Initially we thought that the Reserve Bank would hasten slowly with rate cuts, but clearly we were wrong. In 2001, the Reserve Bank was forced to cut rates by 2 percentage points in the space of 11 months in response to the deterioration of the global economy, especially the US. Now with the global economy again staring down the barrel of a major slump, the Reserve Bank felt that similar dramatic action in cutting rates was required.
- Investors will have to re-assess the strategy of putting the bulk of funds in cash-based investments rather than other asset classes. Property clearly looks a much more attractive investment, especially with rents soaring and demand super-strong. Investors also need to put shares back on the radar screen. However given the on-going global risks, we still advocate a relatively defensive posture. Healthcare, utilities and consumer staples are favoured at present and diversified mining for longer-term investment.
- The Reserve Bank may not cut by 1 per cent again, but rate cuts still lie ahead. Tight monetary policy settings are not appropriate in the current environment and a cash rate of around 5.00-5.50 per cent is likely over the next 6-9 months. Neutral monetary policy is around 5.50 per cent.
- The next inflation figures won’t be a barrier to another rate cut in November. The Reserve Bank has already flagged an inflation rate of 5 per cent – but that is expected to be the peak.
Source Craig James, Chief Equities Economist, CommSec
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