Reduced interest rates indicate RBA’s concern about a slowing economy

Reduced interest rates indicate RBA’s concern about a slowing economy

While widely applauded by the housing and retail sectors of the economy, the Reserve Bank’s decision to reduce the official short-term interest rate to 4.5 per cent is not good news for investors.

Apart from reducing future cash and term deposit returns, this decision highlights Reserve Bank concern about a slowing economy.

World financial markets are questioning the medium and longer term viability of the latest Greek sovereign debt solution with the OECD already reducing its European growth projections.

The United States and Japanese economies also remain weak.

As a result, the future strength of the Australian economy will be even more dependent on continuing growth in Asian economies, particularly China and India.

Iron ore prices have fallen by 20 per cent in recent months from what admittedly are historically high levels because of reduced Chinese demand and copper prices are now well below earlier peak levels.

Chinese data released this week also indicates a slow-down in manufacturing growth which could result in further commodity price weakness.

This, of course, is only to be expected as confirmation of a reduction in world economic growth as high as the 1 per cent reduction forecast by the IMF.

But these are early days yet to be certain about the future movements in commodity prices and their impact on our booming minerals sector and government tax collections.

Even after this week’s rate reduction, Australia’s interest rates are still high compared to those in Europe, the US and Japan.

But further rate reductions of as much as 1 per cent are built into the interest rates being charged on new three and five year fixed rate home mortgages.

If these further rate reductions occur over coming months, there is a real prospect of a falling exchange rate to help offset the impact of reduced export prices.

Nevertheless, given the uncertainty about the European and US economies, the Reserve Bank has a strong reason not to rush in with further rate reduction at this stage.

They need to keep their powder dry to intervene quickly as was done in the first GFC by making a very large rate reduction.

Unless the Federal Government abandons its plan to bring the budget back to surplus in 2012-13, urgent monetary stimulus would be essential if for example, the latest European sovereign debt bail-out does not work and the world economy deteriorates dangerously.

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