Will One Powerful Force Be Enough To Force The Banks' Hand?

The Age

Wednesday August 20, 2008

The answer we already know is that the Reserve Bank plans to cut interest rates. The unanswered question is if the banks will follow suit.

THE Reserve Bank of Australia is . . . well . . . reserved in its official language. So when it begins to use words such as "risk", "clearly quite tight" and "powerful forces", it is time to sit up and take notice. The release yesterday of the minutes of the RBA's board meeting on August 5 not only confirmed the bank was preparing to ease interest rates - although the board decided to leave the rate unchanged in the short term - but provided unambiguous reasons for doing so.

Not surprisingly, the board has put the onus onto the commercial banking sector, saying, in perhaps Cassandra-like tones, "Given there had been a significant change in borrowing behaviour, confidence was weaker, asset prices had declined and slower overall growth was in prospect, tighter financial conditions were not warranted. Indeed, less restrictive conditions could soon be called for, otherwise the risk of a deeper and more persistent slowing in the economy would increase." This, the minutes revealed, make a case for "an early reduction" of interest rates.

This news, while it is to be welcomed, is not exactly new: at the end of last week, RBA deputy governor Ric Battellino told a parliamentary inquiry that the bank was "in a position to respond on interest rates". This unexpected statement from a normally secretive institution means a cut in interest rates will almost certainly be decided at the next RBA board meeting on September 2. The only questions remaining are by how much and will there be more than one cut? (Experts believe the RBA will cut rates by a quarter of a percentage point in September, with a further cut in October or November.)

Another question arises from the August 5 minutes: why did the board not change the rate there and then, instead of waiting another month? Its official reason - "the current stance of policy was appropriate for the time being" - appears curious, especially given the board's own concerns about an economy it says remains "subject to powerful forces pulling in opposite directions", causing slower demand and growth. Surely this forecast would have made a more immediate case for reducing rates. This argument is bolstered by the Australian Chamber of Commerce and Industry, which yesterday released a small-business survey showing a continuing deterioration in conditions during the June quarter because of a slowdown in the domestic economy: the ACCI's conditions index fell to 43.4 from 48.8 in the March quarter, more than 10 points below the five-year average of 54.8. The chamber has said that any interest-rate cuts by the RBA should be passed on in full by the commercial banks.

There remains, of course, the big unanswered question: will the major banks follow suit? As this newspaper remarked only a week ago, in the past 12 months banks have raised rates by 1.5 percentage points, of which just 1 percentage point was the result of rises in the cash rate. The banks argue their independence is necessary because of an increase in funding costs caused by the global credit crunch. At the same time, it cannot be ignored that over the last six-month reporting period Australia's five major banks reported a 12.5% increase in post-tax profits on the year before. As The Age's economics editor, Tim Colebatch, wrote last week, ". . . nor is there anything to justify our highly profitable banks holding back part of the interest rate cuts from households".

It might be fanciful to suggest that the RBA has held back its interest-rate decision in order to allow the banks time to consider their options. There is, however, a glimmer of hope that, more than likely, the banks will pass on the first cut in full. As JPMorgan's economic research unit indicated yesterday, this compliance, although partly due to political pressure, would be more the cause of "competitive tension in the home mortgage market than the threat of retribution". There is also the intriguing possibility that one of the big five - soon to be four if Treasurer Wayne Swan and shareholders approve the $18 billion Westpac-St George merger - might lower its mortgage rate after the RBA by more than 0.25 of a percentage point. This would represent the first time in 12 years that interest rates came down independently of the Reserve Bank. More important, it could, if realised, provide whichever bank has the courage to go it alone the possibility of putting itself in genuine competition with the others. After all, in theory, there are more banks in competition than there are, say, airlines or supermarkets, and the consumer has just as much right to expect favourable results accordingly.