RBA to wield rate knife with caution

CONTINUED strong demand from China for raw materials is likely to stop the RBA from granting home owners two consecutive rate cuts.

RBA to wield rate knife with caution

CONTINUED strong demand from China for raw materials is likely to stop the Reserve Bank of Australia from granting home owners two consecutive rate cuts.

New figures from the Australian Bureau of Statistics released yesterday showed business investment was surprisingly strong in the second quarter, with capital spending up 5.7 per cent, well above the 2 per cent expected by economists.

Market watchers now say the RBA is likely to cut interest rates from 12-year highs next Tuesday but then wait until November to make a second cut.

Until yesterday most economists were expecting cuts in September and October.

"The report will encourage the Reserve Bank of Australia to be measured in its easing cycle," ICAP senior economist Adam Carr said.

CommSec equities economist Savanth Sebastian said the turmoil in financial markets and weakening consumer sentiment had not hurt investment plans.

"Rumours of the death of the Australian economy are overdone," Mr Sebastian said.

"CommSec still expects the Reserve Bank to cut interest rates by 25 basis points next week. However, the latest result will clearly water down the more optimistic market views of rate cuts in coming months."

The figures pushed up the Australian dollar to flirt with US87c. Late yesterday it was trading at US86.61c, up from the US86.05c at the beginning of the day.

ANZ senior economist Katie Dean agreed the RBA would take a more cautious approach to cutting the cash rate from 7.25 per cent.

"Twenty-five basis points looks a done deal next week, but further rate cuts from there have just become a whole lot less certain," she said.

She also said yesterday's data was unambiguously strong and pointed to an expanding economy, which would be shown when the June-quarter gross domestic product figures were released next week.

"The data should be enough to keep GDP growth positive in the second quarter," Ms Dean said.

"Look for the consensus forecasts to move higher towards 0.5 per cent."

The outlook for spending in the year ahead was also encouraging, with the ABS raising its estimates for expected spending on capital expenditure for the 2008-09 financial year by 30 per cent to $30 billion a quarter.

The resources sector led the way in the second quarter with investment rising by 8.1 per cent as miners tried to keep up with demand from the growth Chinese and Indian economies.

"The mining boom remains the key part of the of capex story," Commonwealth Bank economist Michael Blyth said.

"Mining is also the part of the story where the lags are the longest between investment and ultimate payoff (but) we are now at the point where many mining projects are entering the production stage."

Meanwhile, manufacturers cut spending by 3.9 per cent.

The mining sector expects a 40 per cent lift in investment plans from last year and those in the manufacturing sector raised their investment intentions by 19 per cent.