Turmoil Points To Cut In Rates

The Age

Wednesday September 17, 2008

By Peter Martin and Eric Johnston

PROSPECTS for another cut in official interest rates have soared after a second day of upheaval on global financial markets.

As share prices tumbled again yesterday following the collapse of US investment bank Lehman Brothers, there were fresh indications that the Reserve Bank could deliver more relief to Australian borrowers at its board meeting on October 7.

The minutes of the bank's September 2 meeting, released yesterday, contain no hint of follow-up rate relief after it cut official rates this month by 0.25 percentage points - the first cut in more than seven years.

But the failure this week of Lehman Brothers, the fire sale of its rival Merrill Lynch and an impending worldwide shortage of capital have dramatically altered the outlook, with new risks to the financial system and the economy now weighing on the central bank board.

One risk is that it will become harder to borrow on world markets. The Reserve has spent about $4 billion in two days pumping liquidity into the financial system to ensure banks have ready access to cash - a move mirrored by central banks around the world.

Another risk is that the US will slide into recession, dragging down the world economy and commodity prices with it. That would slow the Australian economy and ease inflation risks.

There is also a risk that Australians will spend less in response to the slide in share values.

Australian shares fell 1.7% on Monday and a further 1.4% yesterday. This was less than investors had feared after overnight routs in Europe and New York, which suffered its biggest falls since the aftermath of the September 2001 terror attacks.

However, while the Australian market as a whole escaped heavy losses yesterday, bank stocks were pounded amid concerns over more than $400 million in exposures to Lehman Brothers. ANZ and Commonwealth were among the big local creditors to Lehman, which has $US613 billion in global debts.

Regulators yesterday were also scrutinising the Australian arm of insurance giant American International Group, which is trying to secure more than $US70 billion in emergency funding to head off collapse.

AIG Australia, which provides life and general insurance, last night attempted to reassure customers that its finances were sound. "AIG Life in Australia has more than sufficient capital and reserves to meet our obligations to policyholders," managing director Stuart Harrison said.

In Parliament, Prime Minister Kevin Rudd warned that the global financial crisis had a "long way to run" and said it was important to acknowledge that Australia was "not immune".

The futures markets yesterday pushed up further the implied probability of an official interest rate cut on October 7, with suggestions now that the Reserve board might cut rates by more than 0.25 percentage points.

CommSec economist Craig James said: "A week or so ago, most people would have thought a rate cut in November was a more likely event, but a lot has changed in a short space of time . . . I think now the Reserve Bank would be more inclined to be cutting rates in October."

But other economists warned that if the latest shocks caused credit markets to seize up again, some private banks could raise rates to claw back higher costs.

© 2008 The Age

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