Macquarie Research Economics Report

Australian economics
February interest rate outlook
Event
􀂃 We review the outlook for interest rates following the RBA’s decision to cut the
cash rate by 100bp and the release of its quarterly Statement on Monetary
Policy (SoMP).
Impact
􀂃 In the wake of an increasingly dire global economic outlook, Australian
policymakers have been very decisive and aggressive in attempting to
insulate the domestic economy. The RBA has lowered the official cash rate by
a substantial 400bp since September and the effectiveness of monetary policy
in Australia is highlighted throughout the SoMP. While the RBA are not about
to rest on their laurels, the tone of the quarterly Statement suggests that
interest rates are now approaching a trough, likely at 2.50% by mid-2009.
Analysis – rates decelerating towards their nadir
􀂃 The RBA cut interest rates by 100bp in February, bringing the official cash
rate down to 3.25%. The Board cited "a significant deterioration in world
economic conditions" and "a significant dampening effect on (domestic)
confidence" as reasoning behind the large reduction in interest rates.
􀂃 The capacity of monetary policy to impact on activity in Australia is evidenced
by the swift and full pass through of the rate cut by the major banks into
standard variable mortgage rate reductions. Importantly, credit card and
business lending rates have also been lowered, although not necessarily by
the full 100bp.
􀂃 Meanwhile, the Reserve Bank's quarterly SoMP has revealed a very cautious
outlook for domestic activity, driven by increasingly pessimistic views
surrounding the global economic outlook. In the three months since the
Bank's last SoMP, the global economy has deteriorated significantly further.
􀂃 That said, the Australian economy is still forecast to marginally side-step a
recession given that "the impact on domestic growth will be moderated by the
easings... in monetary and fiscal policy and by the significant depreciation in
the exchange rate".
􀂃 The RBA has significantly lowered their expectations for GDP, with growth set
to trough at 0.25% mid-way through 2009. This very small increase in growth
is due to a bounce in rural production, with non-farm GDP falling to 0%YoY
growth.
􀂃 A key reason behind the downgrades in the growth profile stems from the
Bank's increasingly pessimistic view on global economic conditions. The RBA
sees trading partner output contracting by 0.75% in 2009, down from annual
growth of 5.25% in 2006 and 2007. It is important to note that this represents
even weaker assumptions on global economic activity than suggested by the
IMF only two weeks ago.
􀂃 The weakness in domestic economic activity means that the bank now sees
employment falling over 2009, with "the unemployment rate rising materially
over the next year or so". While the bank does not provide a forecast for the
unemployment rate, a small decline in employment over the year is broadly consistent with an unemployment rate of above 6% by the end of the year.