Time for RBA to start cutting rates

THE economy has changed suddenly and sharply. It points to a very different 2009.

THE economy has changed suddenly and sharply. It points to a very different 2009.

For starters, prepare for official interest rate cuts now. The Reserve Bank wants to cut next week. It will cut next month.

This is dramatically at odds with market expectations and the economentariat's perceptions - which even after yesterday were only tentatively projecting a rate cut late in the year, with some commentators still locked into the mindset of "predicting" no further rate increases.

The broad dimensions of the shift are captured in the statistics issued yesterday.

The growth in consumer spending - and credit approvals - have slowed to a walk. While the basic trade numbers have moved sharply and sustainably into the black, as the commodity boom has at last kicked in.

Now the first part will receive the greatest attention. It explains the coming rate cut - cuts - and will spark criticism of the RBA for strangling the economy.

Inevitably, irresistibly, the March rate increase will be castigated as "one too far". Indeed, the "usual suspects" will be claiming all the increases were too far.

The second shift is just as significant. It means we could be heading for a current account deficit in the 2008-09 year as low as $30 billion.

That would be half the $60bn predicted by Treasury in the Budget in May.

It would also compare with an annualised deficit approaching $80bn as recently as the March quarter, the latest for official figures.

Such a fall comes just in the nick of time, so to speak - reducing our reliance on global financial markets when they are under such great stress and turmoil.

The retail sales and credit figures round off a series of important data on the state of the economy and put the big picture beyond all doubt.

The growth rate for retail sales had been slowing from month-to-month since the middle of last year. In real terms it was barely positive in the March quarter and turned negative in the June quarter.

Throw in housing finance and building approvals hitting (at least) decade-long lows; and the RBA has clearly achieved its objective of slowing consumer and related demand.

Has it 'over-achieved'? Has it - in conjunction with all the other factors which have eaten into consumer disposable incomes, like petrol prices and discretionary rate rises from the banks - gone too far?

We will of course find out in the fullness of time. But before then, the RBA will have switched to rate cuts to pre-empt the worst of the slowdown, and to cut into falling inflation rather than waiting for the clear evidence of it falling - and the bodies - to mount.

It is important to understand what the RBA wanted to achieve; and even more importantly what it now wants to achieve running through 2009.

It broadly wanted to slow consumer spending down from an unsustainable and economically dangerous 6-7 per cent growth rate to something more like 1 to 1.5 per cent.

With growth in retail sales - the biggest component, but not the entirety of consumer spending - going negative, has it gone too far?

Certainly we can say that it's gone "far enough" to spark the RBA shift to rate cuts.

Crucially, the RBA wants to sustain subdued consumer spending at that sort of level right through 2009.

It doesn't want it to bounce straight back to the boom-time 5 per cent-plus growth rates. Or even quite subdued 3-4 per cent growth rates. But nor does it want it to go or to stay negative.

That informs its early switch to rate-cutting. But also why it's not going to cut and cut and cut. But to moderate outcomes for the economy.

Even more crucially, so it stays ahead of the game. Cutting into falling inflation before it is clear that is being delivered.

Assuming it hasn't got behind. The best evidence in the RBA's favour is the state of the labor market.

We haven't seen massive job-shedding. We also haven't seen any serious wages breakout.

So the first rate cut will come in September. What unfolds over the next four weeks will determine whether it's a quarter or half a per cent.

After that we will be on monthly watch.

The turnabout in the trade balance has also been dramatic. You only have to go back to February-March when the monthly numbers were running $2bn and even $3bn in the red.

Now we've had two quite significant surpluses in the last three months, averaging half a billion dollars. It is reasonable to project a trade surplus of $8-10bn.

And it certainly wouldn't surprise if it hit $20bn, as prices - and volumes - for commodities such as iron ore and coal kicked in.

The main factor is exactly that: the commodities boom. But the growth rate for imports has slowed with the slowdown in consumer spending. Notwithstanding the rise in the dollar making imports cheaper.

Again next's year's trade surplus will depend on those two factors. The commodities boom impact on export values and the mix of a probably lower dollar and still restricted domestic demand on imports.

You have to add the income deficit - essentially interest on our foreign debt - to the trade balance to surplus to get the overall current account deficit (CAD) number.

That income deficit will run around $45-50bn this financial year. So the likely trade surplus should reduce the CAD to around $40bn. And perhaps to as low as $30bn.