Saturday, July 16, 2011

Good news for bad reason: rates tipped to fall

THE Reserve Bank will cut interest rates four times over the next year or so, as Australia slumps into a marked slowdown, with unemployment rising and consumers saving instead of spending, Westpac has forecast.

Breaking ranks with other economists who forecast rate rises and a boom year ahead, Westpac's chief economist, Bill Evans, said growth would remain stuck in second gear in 2011 and 2012 - forcing the Reserve to take back its last four rate rises.

''Interest rates are too high in Australia, given the state of the non-mining sectors of the domestic economy,'' Mr Evans said. ''A downward adjustment is required to avert a damaging round of contraction.''

His forecast comes as ratings agency Standard and Poor's warned there is now ''at least'' a 50 per cent chance that it will downgrade $14 trillion of US government debt unless Republicans and Democrats agree on a $4 trillion deficit reduction package.

If the stalemate over the deficit is not resolved by August 2, the US will run out of money and default on debt repayments. Analysts say this would trigger a second global financial crisis.

US President Barack Obama wants to cut $US4 trillion from forecast deficits over the next 10 years by cutting spending and closing off more than 150 tax loopholes. Republicans are insisting that the loopholes remain.

Mr Evans predicts that global growth will be below average in 2012, with Europe possibly in recession. Slow global growth will slash Australia's export prices and send the Australian dollar back below the US dollar.

He forecast that the Reserve would take time to concede that it had overdone the monetary tightening. But Westpac expects the first rate cut in December, to be followed by cuts every three months or so in 2012. If it is right, that would cut $250 a month off the cost of servicing a typical $300,000 mortgage, saving home buyers $3000 a year.

But what would be welcome relief for home buyers would also see widespread job losses, particularly in retailing, wholesale trade, manufacturing, non-mining construction and finance.

Westpac predicts unemployment will rise from 4.9 per cent now to 5.7 per cent within a year. That implies 100,000 more people unemployed.

''The Reserve Bank has made it clear that it welcomes softer activity in the household/housing sector to create [spare] capacity for the mining boom,'' Mr Evans said.

''We assert that it will see it is over-achieving, given that consumer spending and housing investment represent 60 per cent of economic activity, while mining investment is around 4 per cent.''

He said concerns over the carbon tax have contributed to a slide in consumer confidence, now at its lowest level since the global financial crisis.

Mr Evans said a similar slump before the GST came in lasted until some months after it had taken effect. ''With the carbon price not due to be introduced until July next year, it is likely to remain a drag on confidence for some time yet,'' he said.

The sharpest fall is in households' perception of their own financial situation. Mr Evans said households' forecasts of where they will be in 12 months' time is ''at extremely weak levels, only recorded on three previous occasions - during the recessions of the early 1980s and early 1990s, and in mid-2008''.

His grim forecast sent the Australian dollar plunging half a cent in half an hour on financial markets yesterday. Futures markets are predicting one or two rate cuts in coming months, but a Bloomberg survey found most market economists still predicting a rate rise by November.

David Jones chief Paul Zahra this week blamed the carbon tax debate for causing the worst conditions for retailers in 20 years.