Rates Cut On The Way: Reserve

THE second-most senior official at the Reserve Bank has broken with tradition and revealed that an interest rate cut is imminent.

Normally secret, the recommendations that go before the Reserve Bank board are closely guarded to allow members to make decisions as they see fit.

Prime Minister Kevin Rudd, meanwhile, yesterday repeated his assertion that the banks should pass on to customers any cuts made by the Reserve or "suffer collective damage to their reputations".

But Commonwealth Bank head Ralph Norris said he would not be dictated to by government. "I don't think we live in a communist country," he told the ABC.

The Reserve's deputy governor, Ric Battellino, yesterday told a parliamentary inquiry that the bank was "in a position to respond on interest rates".

He added: "The bank took the view that it had to take measures to stop inflation going higher. The aim was to slow down demand, to make it harder for businesses to widen their margins and to force businesses to start cutting their margins again. That has happened. That's been successful."

Mr Battellino said households had responded well in cutting back on spending. "We set out to bring inflation back to the target range, and we are confident that we are on that path. And that's why we are in a position to respond on interest rates."

Within minutes, the admission pushed the Australian dollar down below 87 US cents; it hit a low of 86.70 before recovering to close just above 87.

Asked how the Reserve Bank could be preparing to cut its rates at a time when it was forecasting inflation to climb to 5%, Mr Battellino said the bank could not wait to see a fall in inflation before starting to cut, "because by then it would be too late".

He said the bank's policy had "always been to be pre-emptive", whether tightening or easing policy. "The Reserve Bank now finds itself in a position where it is able to think about cutting interest rates."

The declaration leaves only one question to be decided at the bank board's September 2 meeting - the extent of the cuts.

Macquarie Bank economist Rory Robertson, who attended the inquiry's hearing, said it was increasingly likely that the cuts would come in two instalments: 0.25 percentage points next month, and a further 0.25 percentage points at the board's following meeting on October 7.

Two cuts of 0.25 per cent each would take a combined $90 per month off the cost of repaying a $250,000 mortgage if fully passed on by the banks.

He said their total funding costs had "probably fallen by 0.25 percentage points or 0.30 percentage points". -- With AAP

KEY POINTS

? Reserve Bank in unprecedented interest rate tip.

? Two-stage cut could cut home repayments by $90 a month.

? PM urges banks to pass on cuts.