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Thursday, 26 July 2012 02:01

Australian Official Interest Rates - Further to fall

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Westpac Consumer Confidence index was released in July showing an improvement in Consumer Sentiment.

Finally we have some evidence that the Reserve Bank’s policy of cutting the official cash rate by 1.25% between November last year and June this year is starting to gain more positive traction with households.

However, this result is far from convincing and should not be interpreted that we can expect confidence to steadily return to more normal levels over the months ahead.

The Index is now 2% above its level in October last year prior to the beginning of the rate cut cycle. However it is still 4.1% below the reading in November last year when households responded positively to the first rate cut in November. Following that initial
positive response in November concerns around the international and domestic economic outlooks offset any positive impact of the rate cut in December. These ongoing concerns, particularly around the international economic outlook, continued to mute the impact of subsequent rate cuts in May and June. In fact, despite the cumulative cuts of 125bps we still have the situation that pessimists slightly outnumber optimists.

Over the month, households were probably buoyed considerably by the result from the Greek elections and the positive reception to the latest European leaders’ summit , averting, at least for the time being, a new crisis in Europe.

While the Reserve Bank did not cut interest rates further there was a strong 5.5% jump in the confidence of those respondents who hold a mortgage.

There was also some positive news around the domestic economy.Petrol prices are down by 7% since the last survey and have now fallen 13% since May. The Australian dollar rallied from 98¢ to 102¢ versus the US dollar, and the share market rose 2.7%.

All components of the Index increased in July. The sub-indexes tracking consumer expectations for economic conditions over the next 12 months and five years increased by 5.8% and 5.2% respectively. The sub-index tracking responses on ‘whether now is a good time to purchase a major household item’ rose by 1.1%.

Respondents were also more positive around their own finances. The sub-indexes tracking assessments of finances relative to a year ago improved by 4.6%; and the outlook for finances over the next 12 months improved by 3%.

However, disturbingly, the sub-index tracking respondents’ outlook for their finances over the next 12 months is still 9.4% below the level in October last year prior to the beginning of the Reserve Bank’s rate cut cycle.

The Board of the Reserve Bank next meets on August 7. It is our view that interest rates in Australia are still too high. In his Statement following the interest rate decision on July 3 the Governor described interest rates as “a little below medium term averages”. With the Australian dollar back above parity, despite lower commodity prices, and fiscal policy being quoted by the RBA to be contradictionary in the order of 0.75% – 1.5% of GDP financial conditions in Australia are mildly stimulatory at best. Although there are tentative signs of improvement emerging in some interest rate sensitive parts of the economy, these have yet to show a convincing recovery and remain vulnerable to renewed weakness. Mean while the threat from a deteriorating global economic outlook continues to build.

Not with standing these issues the recent rhetoric from the Bank indicates that it is in a ‘wait and see’ mind set. Accordingly, whilst we think it is likely that, as we saw in the first half of 2012, the Bank’s ‘wait and see’ approach will eventually evolve into further
rate cuts totaling 0.75%, our call that the next cut will come in August could prove to be too early. However, because we believe that Australia needs lower rates and much can happen, particularly in the international economy, we are comfortable
maintaining that view.

Sourced from Bill Evans -Chief Economist Westpac

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