Tuesday, November 25, 2008

Good news and bad news

If the Debt Futures Market (DFM) know their stuff, the Reserve Bank of Australia (RBA) is going to lower its cash target rate to 2.75 per cent by April next year. That represents a fall of another two and a half per cent from the current cash rate 5.25 per cent. To kick off this reduction, markets are pricing a massive cut of 125 basis points when the RBA meets at its next board meeting on December 2. That would be the biggest one-month cut in official rate since the onset of the 1990 recession.

If these forecasts prove correct, the cash rate will be at its lowest level for several decades. According to the monthly average of official daily data published by the RBA , the cash rate was at a low of 2.98 per cent in January 1960.

Economists argue that a shrinking Australian economy, falling asset prices and recession-like levels of business confidence will make the RBA more inclined to cut rates aggressively. A 125-basis-point rate cut next month would take the cash rate to 4 per cent. It would be the biggest cut since April 1990, when the RBA slashed the then 16.5 per cent cash rate by 150 basis points, as the Australian economy entered into a recession.

This is both good news and bad news.

  • Good news because exsitng and new mortgages will be so much more affordable. In the long run, this will help the broader economy in areas like retail, property and personal and business services.
  • Bad news for people who rely primarily on bank deposits for income (retirees) as deposit rates fall.
  • Good news for equities markets as return on investment in shares become more attractive relative to income earned in bank deposits

However, its really bad news though because rate cuts of this magnitude highlight the seriousness of the economic conditions we are about to head into.

(source: Faifax Ltd)

3 comments:

Tom Thorne said...

Can you tell us why the price of gas is dropping so severely? I think it's a lot more than just supply and demand.

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Mortgage Broker said...

It would be great to know where your sources are for a reduction to 2.75% by the RBA. From there recent minutes, we might not be too far from the end of the rates cuts, but I guest the indicators will let us know within a few months. Great topic.