Wednesday, September 3, 2008

The Rate Cut We Had To Have

It was absolutely no surprise that the Reserve Bank Board decided to cut official interest rates by 0.25% yesterday. It was so widely anticipated that the announcement was only a formality. At the same time, observers were paying careful attention to what the Bank actually said about its decision, hoping for some clues as to the direction of future decisions. What they got was a forecast for economic growth to slow to 2% by the end of the year, while at the same time inflation continues to be a concern. Far from hedging bets, this apparent conflict is a reflection of the so called “two speed” economy which has sprung up from the strength of the resources boom.

The effect of that two speed economy is even more evident today with the release of the latest batch of economic figures. The bottom line is that the economy has slowed by more than expected. The June quarter economic growth figure fell to 0.3%, giving an annualized outcome of 2.7%. More alarmingly, household consumption fell for the quarter by 0.1%. After the widely reported slump in retail sales already reported this year that is no real surprise, although actually registering a negative figure is worse than expected. At the same time business investment remains robust.

On balance, today’s figures are worse than expected, and can be read as an indication that the decision to cut interest rates was the right one. In fact there are still many who believe that the previous increase was one step too far, and they may be right. Despite the ongoing resources boom, and the strength of business investment, the key parts of the economy which affect ordinary Australians in their day to day lives are perilously close to going backwards. After seven years of increasing interest rates, this was the turnaround that we had to have.

That doesn’t mean that from here on out it will be clear sailing. Far from it. If anything the challenge is only just beginning as the economy seeks to find its own equilibrium, and the Reserve Bank attempts to smooth out an otherwise bumpy ride. There’s still a long way to go before the balance between equity and debt, as well as capital and income, is restored.

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