The Reserve's Big Bang

The Age

Wednesday October 8, 2008

Josh Gordon, Canberra

THE stunning decision by the Reserve Bank to cut interest rates by a full percentage point has shocked local financial markets back into life - at least temporarily - and is set to deliver bigger-than-expected savings to home buyers.

In an aggressive attempt to stop Australia following its trading partners towards recession, the Reserve yesterday slashed its official cash rate from 7% to 6% - its biggest one-off intervention in the economy since the 1990s recession.

The size of the cut caught almost every expert in the country by surprise - it was double what had been predicted - and prompted an immediate reversal in what had been a black day for the sharemarket.

Announcing the cut, Reserve governor Glenn Stevens warned there was growing evidence of a significant slowdown in growth among Australia's key Asian trading partners.

"The recent deterioration in prospects for global growth, together with much more difficult market conditions even for creditworthy borrowers, now present the risk that demand and output could be significantly weaker than earlier expected," Mr Stevens said.

The large cut signals that the Reserve is now more worried about insulating the economy from the financial crisis than it is about high inflation.

Other central banks are expected to follow Australia's lead, possibly in a co-ordinated attack, and cut their official interest rates aggressively to help stave off recession.

But because interest rates in many other developed economies are already low, there may be limited scope to do so.

The Australian rate cut followed a night of carnage on world financial markets, with shares in Europe recording their biggest falls since the 1987 sharemarket crash in response to the credit crisis and a spate of major bank failures and rescues.

Prime Minister Kevin Rudd endorsed the Reserve's "decisive" action.

"We are dealing with extraordinary economic times ... when some 25 banks around the world have either failed or have had to be bailed out," he said.

"The cornerstone of the Government's policy is to ensure the continued stability of the Australian financial system ... we want to make sure that those who are currently borrowers get relief and at the same time maintaining the stability of the Australian banking system."

Local financial markets were caught off guard by the decision. The stockmarket, which had been reeling from another night of savage selling in Europe and the United States, was down more than 3% in early trading ahead of the Reserve decision.

The resulting rally pushed share prices 1.7% higher over the day.

The ailing Australian dollar, which had plunged below 70 US cents in overnight trading, defied conventional economic wisdom on the effects of lower rates and clawed back some of its losses in local trade yesterday to reach 72.72 US cents.

The Reserve's bid to ward off recession is unlikely to end with this move, but future cuts are unlikely to be as big as this one.

Mr Stevens said the "unusually large" cut was needed to bring about a significant reduction in costs to borrowers. But he said the Reserve did not see the move as "establishing a pattern for future decisions".

Analysts said the Reserve had "front-loaded" future cuts as a shock tactic to lift the economy. Commonwealth Securities chief economist Craig James said: "When a central bank cuts rates by such a large amount, the question is whether it knows something we don't."

National Australia Bank chief economist Alan Oster predicted rates would be lowered by a further percentage point over the next five months, with the first instalment of half a percentage point next month.

Much will depend on the outlook for inflation, which the Reserve thinks was running at an annual pace of about 5% over the year to September 30, but expects to slow to less than 3% next year.

RATE CUT HITS HOME

For the Wright family of Mitcham the Reserve Bank's decision to slash interest rates by one percentage point will mean they can finally get a new roof for their home. The family of four now feel more confident to take on an extra $50,000 debt on their loan to pay for the roof and other minor renovations.

Libby and Colin Wright fixed their home loan rate at 6.69% five years ago but that rate is due to expire and had been expected to climb to 9.42% in three weeks.

So it was with relief that they yesterday learned of the RBA's decision. "It makes quite a difference to us, it means that we can borrow a bit extra to do some renovations we have wanted to do for a long time," Ms Wright said.

STOCKMARKET

The S&P/ASX 200 Index closed 78.3 points, or 1.7% higher, at 4618.7 points. The result was in contrast with European markets that dived between 6% and more than 9% on Monday. The Dow Jones too had lost 3.6%, falling below 10,000 points for the first time in four years.

DOLLAR

ANZ chief economist Saul Eslake says the dollar's decline will offset gains that may have filtered through to motorists because of lower oil prices. The dollar fell close to below $US70 cents for the first time since late 2004 yesterday - a fall of 29% since July.

REAL ESTATE

Yesterday's rate cut should put a floor under falling demand for properties, real estate agents believe. "It's certainly going to get the buying public more confi- dent in the market," says Bill McKewan, director of Hayden Real Estate Ocean Grove.

WHAT YOU'LL SAVE

THE BANKS' .8% RATE CUT MEANS WITH A MORTGAGE OF $100,000 YOU'LL SAVE $57 A MONTH

MORTGAGE OF $200,000 SAVE $114 A MONTH

MORTGAGE OF $300,000 SAVE $171 A MONTH

MORTGAGE OF $400,000 SAVE $228 A MONTH

MORTGAGE OF $500,000 SAVE $286 A MONTH

Assumes a standard variable 30-year loan. Will vary depending on circumstances and bank.