Heat On Rba For Big Cut In Interest Rates

The Age

Monday October 6, 2008

Mathew Murphy and Eric Johnston

THE Reserve Bank of Australia is under increasing pressure to pass on a bigger than expected cut to interest rates this week, with banks unlikely to pass on the full benefit to customers.

While the US Congress' approval of the $US700 billion bail-out of Wall Street could thaw frozen credit markets, restoring confidence among financial companies could take longer, with the program likely to take another month to get up and running.

"Now we have to see the package kicking in and the US Government buying back the bad debt," said AMP Capital Investors chief economist Shane Oliver. "Within a few weeks it should be noticeable whether it is working or not.

"Things will start to stabilise, but of course it is not going to head off the problems we have right now with the economic downturn globally."

The RBA board, which will hold its monthly meeting tomorrow, has previously acknowledged that the impact of official rate movements has been muted by intense competition in the banking sector. With banks paying substantially more for funding, few expect the full cut to be passed on.

Economists have forecast the RBA will cut official interest rates by up to 50 basis points in response to global financial turmoil, lowering its benchmark rate to 6.5%.

This will mark a departure from the usual 25-basis-point movement, a feature of central bank policy since April 2001.

"The cut will be justified on the basis of a deterioration of the global economic environment and further signs of a domestic economic slowdown," said CommSec equities economist Savanth Sebastian.

The Federal Government has refused to pressure banks to pass on the full expected cut in the official cash rate, with Treasurer Wayne Swan saying Australia was in a "more complicated environment" than when rates were cut last month.

BusinessDay last week reported that bank executives had warned government and opposition staff they could no longer afford to track the Reserve's domestic rate targets.

Credit markets have frozen and money market rates keep rising even after central banks pumped an unprecedented $US1 trillion into the financial system.

"Everything has gone up," an executive at a major bank said yesterday.

Pricing on five-year bank funding was running at more than 150 basis points over the benchmark rate, which is more than six times the average of recent years. Most bankers point out that wholesale financing markets have effectively shut down, with banks unwilling to lend to each other.

"Long term the markets aren't even open," the bank executive said. "I can't even say what the costs will be when they open. No one wants to keep rates high, but we have to be realistic about this. We will be passing on what seems reasonable."

Others have described as a "time bomb" the existing bank long-term funding now rolling over at higher costs.

Dr Oliver said the Reserve Bank should not assume that the rescue package would open up credit markets to a point where it decides against a significant cut in interest rates at tomorrow's meeting.

"I think the best thing the Reserve Bank could do would be to cut rates by a decent amount, say 50 basis points, to make sure Australian home owners get a decent cut, especially considering the banks are not really in a position to pass on the full amount," he said.

ANZ chief economist Saul Eslake said markets were likely to act cautiously because no one was certain that $US700 billion would be the magical figure to quarantine the bad debt.

Weaker jobs data in the US proved that the rescue package would not be the panacea for all the market's woes. The Dow Jones Industrial Average on Friday fell 157.47 points, or 1.5%, to 10,325.38.

The Australian sharemarket today is likely to follow the Wall Street lead. Futures trading indicates the market will open about 50 points down.