Fed Steady, Rate Cut Here next Month?

Sydney, Aug 6, 2008 (ABN Newswire) - The US Federal Reserve left interest rates steady at 2% this morning and softened its stance, leaving analysts to forecast no change for the rest of the year at least.

The decision came after oil prices fell under $US120 a barrel, gold shed more than $US20 an ounce to around $US887, copper lost more ground and US stockmarkets jumped more than 2.8%.

The Dow was up more than 300 points in the market's strongest showing since April.

The Australian dollar lost more ground as well, falling under 92 US cents to take its losses in three weeks to more than 7%.

But while the Fed warned that the inflation outlook remains "highly uncertain" it also indicated that problems in the credit and housing markets, as well as high energy prices, are likely to hurt economic growth over the new few quarters.

"Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the committee," the Fed said in a statement.

It was a softer approach, although the comments on inflation indicate there's still concerns about cost pressures.

But the Fed was still conceding that the US economy is now stagnating.

Here in Australia there will be a change next month as we look like getting our first rate cut in seven years, with next month the most popular pick.



At this stage the cut, when it comes, will be 0.25%, but if the domestic economy shows further signs of slowing, with more negative reports for the retail and housing sectors, the Reserve Bank could double its cut to 0.50%.

There was no change in official interest rates yesterday afternoon, with the Reserve Bank revealing that it had left the cash rate unchanged at 7.25%, but the central bank sent a huge hint that a rate cut is coming.

Next month is a big tip from the markets. Macquarie Bank's Rory Robertson last night said a September cut was a 'given" and the National Australia Bank brought for ward its rate cut time table and suggested one could happen on September 2.

Rory Robertson said it could be 0.25% or 0.50% and reckons we will now see rates back at 6% by the end of next year, while the NAB agreed, with it now looking for 1.25% of cuts.

The RBA is now more confident inflation is on the way down. That growing confidence about falling inflation, plus the sharp and accelerating slump in domestic economic activity produced this significant change of heart in yesterday's statement from RBA Governor, Glenn Stevens.

"Weighing up the available domestic and international information, the Board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the Board's view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing."

After the RBA switched to a definite no rate rise stance at the July meeting and let the world know through different wording for the post board meeting decision and then in the minutes (where there was discussion of the extra impact of high oil and petrol prices on consumers), the chances of a cut have swelled as poor retail sales and building approvals for June were released last week, along a further contraction in credit growth in the same month.

Lending for housing, credit cards and other personal credit and for business all showed a noticeable slowing in June and added to the sense that the slowdown in domestic activity the RBA had sought, had accelerated in June. Anecdotal evidence suggested that the same happened in July.

The RBA said in its post meeting statement that it now believes inflation will drop below 3% "during 2010". 

That's after being more equivocal in its July statement when it said: "Looking further ahead, inflation in both CPI and underlying terms should decline over time, provided demand continues to evolve as expected". It didn't nominate a figure or a time for the fall.

In its latest statement the bank indicated that "it is looking more likely that demand will remain subdued, and economic growth will be fairly slow, over the period ahead."

For that reason, the RBA is more confident inflation will fall over the next two years. 

In fact with oil prices down and the way economies seem to have peaked around the world, there's every chance the inflation cycle peaked at an annual 4.5% in the June quarter.

The change of approach came a year to the day after the RBA began the final round of four rate rises just two days before the credit crunch broke over world markets.

Since then those four rate rises, plus the surge in oil prices and non official rates caused by the crunch, have slashed demand in Australia and many other economies. 

Here, retail sales and building approvals are now flat to negative, compared to a year ago.

Figures were released yesterday showing that car sales fell in July, but are up of where they were a year ago, despite the record level of petrol and oil prices so far in 2008.

In the latest VFACTS sales bulletin released yesterday, the Federal Chamber of Automotive Industries (FCAI) said 83,976 new vehicles were retailed last month compared to 86,291 in the same month last year.

But the market was still ahead on a year-to-date basis with total sales to the end of July still 2.6% ahead of the same period in 2007.

But commodity prices are now falling: July saw oil prices peak at over $US147 a barrel, and then help pull all commodity prices down by the largest amount in 28 years; that's a fall that has continued this month with another sharp decline Monday night and yesterday. 

Oil was trading at a three month low of just under $US120.overnight.

That has pushed Australian sharemarkets down to a two year low this morning, and the Australian dollar down to a new three month low. 

The Aussie dollar weakened to 92.40 US cents after the RBA decision was announced, a new 12 week low; and fell further to 91.54 US cents this morning in New York.

The Aussie dollar is now more than 5% off its peak last month at just over 98 US cents. 

If the currency continues to weaken with the rate cut speculation and lower commodity prices, it will start cutting the flow on effects from the falling world oil prices.

But we will get another update on the state of the economy with the July employment figures, due out late this morning.

Macquarie Bank interest rate economist, Rory Robertson said before the RBA decision

"My thinking is that if the RBA doesn't cut today, then it very likely will cut next month. The RBA is set to respond to the fact that extremely tight financial conditions are bringing the Australian economy to a screeching halt.

"Yet it is the RBA's worry about the growing risk of recession that will drive its first cash-rate cut in seven years.

"The RBA's initial cut - whether today or next month - should be read as an acknowledgement of the growing risk of recession, driven by financial conditions that have tightened more than the RBA ever planned or anticipated (via market-driven interest-rate "top ups" and a sharp tightening of lenders' credit standards)."

He later firmed up his forecast.

Besides the fall in July car sales (and local production, which was also down noticeably), the service sector further contracted last month according to a survey from the Australian Industry Group.

The Australian Industry Group-Commonwealth Bank performance of service index fell 2.6 points to 42.8 points, from 45.4 points in June - the lowest on record since the index began in February, 2003.

July's reading was the fourth consecutive reading below the 50 point level that separates growth from contraction.

''The combination of the credit crunch, consecutive official and market based interest rate increases and high petrol prices are hitting services sales hard, while weak readings for new orders, inventories and employment paint a less than rosy outlook for the sector in the months ahead, the AIG said in a statement.

The AIG said the weakness was seen across most sectors and most states.

The RBA is now more certain about the future direction of inflation than it was a month ago, and more confident the slowdown in domestic demand is cutting inflationary expectations and that inflationary pressures will ease.

It is important to understand that the bank still sees inflation as its major concern, not the current sluggish state of the domestic economy.

Because the resource sector, especially coal mining and exporting and the iron ore sector are still doing well, with more income to arrive in the economy in the next few months, the RBA remains wary of any possible inflationary rebound.

The headline Consumer Price Index rose 1.5% in the June quarter, for an annual rate of 4.5% (the same as the RBA's more favoured measures). 

That was higher than expected and conditioned the bank into not cutting rates yesterday, judging from market chat.

That's why rates were not cut yesterday, but will almost certainly be trimmed next month to 7%.

The RBA board will next meet on September 2.

Then we have to ask, will the banks follow?


 

AIR publishes a weekly magazine. Subscriptions are free at http://www.aireview.com.au