The stockmarket rejoiced, rising 1% or more after the news was released, but we should remember the reality of a 1% rate cut.
It’s essentially confirmation by the Reserve Bank that the good times are not around the corner; in fact it means that tougher times are approaching and the much bigger than expected cut (and more to come) is an attempt to brace the economy to limit the impact.
The Reserve Bank’s slashing of its key cash rate by an historic 1% to a new level of 6% will also force the banks to pass as bigger rate cut on to bank borrowers as can be passed on.
It was all about getting on the front foot for the RBA, a point the National Australia picked up in its comment.
“Basically, we see today’s RBA statement and in particular the 100 point cut in the cash rate to 6% as an attempt to be pre-emptive and try to stabilise economic and financial conditions in very uncertain times,” the NAB’s head of economics, Alan Oster said.
“The first two paragraphs of the statement are all about the global liquidity and liquidity crunch and the prospect that it will seriously hurt world activity and Australia’s trading partners.
“They also say that the real economy in Australia is travelling fairly much as they expected (presumably similar to Nab’s growth forecasts).
“Basically, the RBA wants to get on the front foot and also significantly lower the cost of funds to banks and in turn borrowers,” he said in a statement last night.
The size of the cut not only caught markets by surprise: the banks were also wrong-footed. In September when the 0.25% cut was announced, the majors all had statements ready to roll within 10 minutes of the 2.30 pm announcement.
This time there was nothing from the banks for two hours until Westpac revealed a cut of 0.80% in its home loan rate while Aussie Home Loans, 33% owned by the Commonwealth, said it would be cutting by 0.7%. The NAB said it wouldn’t reveal its decision until markets had calmed down. (Translation: we want to see what the others do because we are doing it a bit tough with those CDO write-offs etc.).
The Commonwealth Bank, the NAB and the ANZ will also cut their standard variable rates by 0.80% from Monday.
The RBA’s move was also aimed at forcing the banks to pass on more than they perhaps would have if the cuts had been spread over two months.It wanted borrowers to get the biggest possible benefit, and through them, the economy as a whole.
It has seen the carnage and destruction of confidence overseas, especially since Mid-September, and is determined that it will try and get us through the storm with as little an impact as possible.
But there will be fallout: the central bank fears the economy is slowing faster than expected because global demand is slumping sharply towards a very hard landing and a very deep recession.
The cut takes rates back to where they were in August 2006.
There’s every chance we will get further rate cuts in November and December if global financial and economic conditions continue to worsen.
The RBA last cut rates by 1% in May 1992 in a series of five 1% cuts in 13 months from May 1991.
The RBA Governor, Glenn Stevens said in the post meeting statement that the board wanted a larger than normal increase to bring about "significant reduction in costs to borrowers".
He also warned that growth in demand and output could be weaker earlier than expected, which is a nice way of saying that the risks of a quicker than expected slowdown in the economy have risen.
He said: "Conditions in international financial markets took a significant turn for the worse in September.
"Large-scale financial failures in several major countries were accompanied by serious dislocation in interbank markets and heightened instability in other markets, including sharp falls in share prices.
"Official actions in a number of countries have been aimed at restoring stability, by adding to short-term liquidity and laying a foundation for longer-term recovery in the health of balance sheets. Nonetheless, financing is likely to be difficult around the world for some time ahead.
"This is also affecting Australia, albeit by less than in many other countries, given the relative strength of the local banking system."
The move flies directly in the face of the long held view in central banking that it’s best to work in small increments.
In fact there’s something of an adage in central banking that the bigger the cut in interest rates, the greater the level of concern about the economy.
Central bankers prefer to work in gradations of 0.25%, and even a 0.50% cut is big news and a decision not lightly made.
US Fed Chairman, Ben Bernanke raised eyebrows earlier this year when he chopped the Federal Funds Rate by 0.75% a few weeks after cutting it by 0.25%.
But the RBA’s cut is unprecedented among major central banks around the world.
The cut, revealed this afternoon at 2.30 was made because there had been a material change to the balance of risks surrounding the outlook had occurred, requiring a significantly less restrictive stance of monetary policy.
The bank made it clear that the huge cut, last seen in the early months of the 1991 recession, should not be seen "as establishing a pattern for future decisions".
It’s a clear one-off and should be seen so.
But the RBA made it clear that it was looking to force as greater cut in interest rates into the wider economy as it could.
The RBA has noticed the elevated rise in rates in short term markets, but clearly doesn’t see this as an impediment.
"The Board also took careful note of movements in funding costs in who
