RBA to cut interest rates next week

A COMBINATION of a slowing economy, deteriorating business conditions and tight credit markets will lead to a rate cut next week.

RBA to cut interest rates next week

A COMBINATION of a slowing economy, deteriorating business conditions and tight credit markets will ensure the central bank cuts interest rates next week, economists say.

The Reserve Bank of Australia (RBA) on three occasions this month said domestic economic conditions had changed to such an extent that there was increasing "scope'' to move towards a less restrictive stance of monetary policy in the period ahead.

It used those words following its August board meeting, at which the official cash rate was left at 7.25 per cent, in its quarterly statement on monetary policy and in its monthly board minutes.

All of the 17 economists surveyed by AAP believe the easing cycle will begin next Tuesday following the RBA's September meeting, and give mortgage holders with some badly needed relief on their home loan repayments.

Most expect the RBA to end a run of 12 successive rate rises and lower the cash rate by 25 basis points, marking the first cut in almost seven year, or since December 2001.

But one, Westpac senior economist Justin Smirk, has predicted a more aggressive 50 basis point easing of the official rate.

Mr Smirk said a bigger cut was warranted because the turmoil in global credit markets had impacted the domestic economy more severely than the RBA had anticipated.

Mr Smirk described a potential move of 50 basis points as "good policy''.

"Credit growth is actually slowing so the RBA has actually achieved what it wanted to do by raising rates and slowing domestic demand and slowing the rate of domestic credit,'' Mr Smirk said.

"Now is the time to get out on the front foot.''

The RBA's expected shift in policy will come despite its expectation that inflation will remain elevated for some time.

At a charity lunch on July 16, RBA governor Glenn Stevens said: "You shouldn't be waiting until it's really obvious that inflation has gone all the way back down to where we'd like it to be before you can conclude you've got to start doing something, before that day.''

The RBA's quarterly statement on monetary policy, released on August 11, forecast headline inflation, as measured by the consumer price index (CPI), to peak at 5 per cent in the December quarter.

As well, underlying CPI inflation was not expected to return to the RBA's target band of 2 to 3 per cent over the economic cycle until the middle of 2010.

St George Bank acting chief economist Besa Deda did not discount the possibility of a 50 basis point rate cut next week.

But she said the RBA could not afford to be too aggressive, given the outlook for underlying inflation.

Ms Deda said a bleaker global growth outlook and its impact on the domestic economy would force the RBA's hand to a 25 basis point cut.

"We think they will cut rates to mitigate the downside risks from that,'' Ms Deda said.

"We don't think they may be as aggressive as past easing cycles.''

But National Australia Bank (NAB) head of Australian economics Jeff Oughton said the RBA's outlook for inflation is "too bearish''.

While Mr Oughton expects the easing cycle to begin on a cautious note with a 25 basis point cut, he said the RBA will soon realise there is a need to do more given the significant slowdown in domestic demand underway.

Mr Oughton said NAB expected inflation to fall back within the target band by the middle of 2009, six months ahead of the RBA's forecast.

"By the middle of next year, it will be clear that inflation is heading down and the Reserve Bank will have cut interest rates by over 100 basis points,'' Mr Oughton said.

The past two easing cycles, which started in 2001 and 1996, both began with a move lower of 50 basis points.

But the past 15 changes in the cash rate - 12 up, three down - have all been by 25 basis points.