Finance Finance News Will the Reserve Bank cut the cash rate?
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Will the Reserve Bank cut the cash rate?

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It could be even cheaper to borrow money this time next month if the Reserve Bank of Australia (RBA) decides to cut rates on February 3, as a growing number of commentators are predicting it will.

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This is great news if you have a mortgage or want to borrow money to start or grow a business, as it means you will be paying the bank less for the privilege.

But on the downside, it also signifies the economy is not in great shape. When times are tough, lower interest rates are meant to encourage more borrowing, and therefore stimulate more economic activity.

If the RBA does cut rates, it will effectively be saying the economy is in need of a boost.

The Reserve Bank is all but certain to leave rates at 2.5 per cent at its first meeting of 2014.
The Reserve Bank is widely expected to cut the cash rate by 0.5 per cent in 2015.

A sudden shift

Two months ago most experts expected the cash rate would rise from its current level of 2.5 per cent in 2015. Now, with the domestic and global economies taking a sudden turn for the worse, most experts say it will fall.

John Caelli, general manager of markets at ME Bank, is one of them: “Market sentiment has fundamentally shifted over the last two months as oil prices have plummeted and concerns about deflation in Europe grow,” he says.

“This has led to markets expecting 0.5 per cent of rate cuts in the first half of 2015.

“Growth and consumer confidence have been weaker than the RBA would like and the RBA would also like the dollar lower. The RBA may sit tight this month but the probability of rate cuts this quarter is high.”

While most of the banks take ME Bank’s view that a cash rate will come in the next three months, Westpac is bolder in its prediction.

“We expect that by the time of the release of the inflation report next week the case for a rate cut will have been made,” says the bank’s chief economist Bill Evans, adding that “the prospect of moving in February should be attractive to the Bank”.

The Commonwealth Bank is the only one of the big four that expects rates to stay on hold all year.

So what will the RBA do?

The Reserve Bank is constitutionally independent of political or commercial pressures, and is unlikely to be swayed by any bank’s calls.

In its last statement on interest rates on December 2, RBA governor Glenn Stevens clearly indicated that the board did not expect to make rate cuts anytime soon.

But since then the domestic and global economies have taken a turn for the worse, and a rate cut is looking more and more likely.

The business lobby is also getting behind a rate cut, with the Australian Chamber of Commerce and Industry this week calling for rate cuts to be put back on the table to improve what it called a “terrible” business environment.

Market Economics managing director Stephen Koukoulis, meanwhile, called the current rate of 2.5 per cent “absurd”.

“I wouldn’t say it’s urgent but if they don’t cut in February I don’t know what’s going on with them,” he said.

According to the Australian Securities Exchange, market activity suggests a growing number of market participants are betting on a February rate rise (22 per cent on Thursday, up from 18 per cent on Wednesday).

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Housing bubbles can lead to forceful evictions. Photo: Shutterstock

The danger of a housing bubble

One danger of lowering the cash rate is that it will fuel a property borrowing frenzy. In the worst case scenario, this could result in a housing bubble, whereby borrowers are unable to pay back their mortgages and banks either go bust or are bailed out by the taxpayer, as happened in the US during the global financial crisis.

Soaring house prices in Sydney and Melbourne caused economists to talk about a housing bubble even without lower interest rates. However, Mr Evans argues that a recent “cooling sentiment” towards housing means we are no longer in danger territory, and can therefore risk a rate cut.

He is not alone in this position. Shane Oliver of AMP Capital expressed a similar view recently, saying while a housing bubble remains a risk, people are taking on less debt than they were a year ago.

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