The “super-sized” rate cut is good news for business, but banks still hesitant

The Reserve Bank of Australia’s decision to cut the official interest rate by 50 basis points yesterday has been hailed as “courageous” by economists but they warn for the cuts to have a positive impact, banks need to pass on the central bank cut and consumer sentiment needs to improve.

The cash rate is now at 3.75%, the lowest level in two years and yesterday was the first time the RBA had cut rates in five months.

The Bank of Queensland has already cut its rates by 35 basis points in response to the decision, but none of the major banks have cut interest rates yet with the ANZ saying it will not consider reducing its rates for another two weeks.

Even the RBA has implicitly acknowledged that it is unlikely the banks will pass on the full extent of the rate cut.

The central bank’s statement announcing the rate cut noted a reduction of 50 basis points in the cash rate was, in this instance, therefore judged to be necessary in order to deliver the appropriate level of borrowing rates.

Treasurer Wayne Swan said the banks were “very profitable” and “have the capacity to pass through” rates.

Harley Dale, chief economist at the Housing Industry Association, told SmartCompany the rate cut was “most definitely a positive” for the housing industry and very important for loan interest rates for small- and medium-sized businesses.

“Outside the non-resources sector, conditions are very weak and there are hundreds of thousands of small businesses out there in Australia and they are feeling a considerable amount of pain in the housing industry and other industries as well,” says Dale.

“They can now expect some interest rate relief and that is a positive thing for the Australian economy.

“The difficulty that we have is that we can’t call it unequivocally good news that will boost the housing industry because we don’t know what the banks will do with the 50 basis points.

“It looks like whatever they do it will not be the 50 basis points, which does put a dampener on things.

Dale says the Bank of Queensland’s cut would at least set a precedent for the other banks.

“You have got a lender out there who is a significant lender, although not one of the big four, who has set a certain pace, so we will see expectations form over the next few days around the 35 basis point mark.

“It will be difficult for one of the banks to come out with less than that.”

Craig James, chief economist at CommSec, said the cut is a “tremendous decision” by the RBA.

“Not only will the super-sized rate cut provide real stimulus, but it will also boost much-needed confidence.”

However, James said the banks needed to pass on the rate cut and consumers need to spend in order for the cut to be effective.

 “If the rate cut doesn’t cause people to buy or build more homes or spend, employ or invest then the rate cut is a ‘damp squib’ – it is akin to pushing on a piece of string,” says James.

“People don’t just need interest rates to come down, they also need confidence to act on the easier financial conditions. This rate cut provides confidence.

“Ordinarily a rate cut would be positive for retailers and other consumer-dependent businesses. But if home-buyers elect to pay off their home loans quicker, then extra spending power won’t be released into the economy.

“And savers may feel that the rate cut actually reduces their spending power.

“The hope for retailers is that businesses are more confident to take on more workers because a stronger job market is a greater guarantee of increased spending than an interest rate cut.”

The peak retail industry body, the Australian Retailers Association, said retailers were “rejoicing” over the RBA rate cut.

However, ARA president Roger Gillespie said it was now up to the big banks to follow its lead and give retailers the respite they needed by easing the pressure on consumers stretched to the limit.

“Over the past couple of months, retailers have paid for the big banks’ greed after they raised interest rates despite the RBA’s hold on the cash rate in March and April,” says Gillespie.

“However, retailers are today calling on the banks to follow the RBA’s lead and immediately pass on the rate cut in full.

“Retailers are operating in the lower gear of the economy and if the rate cut is passed on in full by the banks, this will go some way to relieve the pressure on a sector operating amid low consumer confidence, a higher Australian dollar and increased global competition.”

The Australian Industry Group also welcomed the cut and said it would help industries on the wrong side of the resources boom but warned it was “not a silver bullet”.

“The size of this reduction is particularly important for non-mining trade exposed businesses in industries such as manufacturing and construction who are currently facing very difficult trading conditions,” AIG chief executive Innes Willox says.

“A full pass-on of the cut by banks to business and household borrowers is essential if the move is to play a part in lifting the economy from its slump.

“The immediate reaction of the Australian dollar – falling half a cent against the USD – bodes well for the benefits this rate cut is likely to bring to Australian exporters.”

As for further rate cuts, the HIA is predicting a 25 basis point cut which “should be in June” but realistically could occur in July or August.

CommSec is pencilling in another rate cut of a quarter of a per cent in August, should it be necessary.

Westpac predicts a further rate cut of 25 basis points in August, when it expects the RBA will get confirmation that inflation is under control, along with a further cut in November.