Drop in inflation makes interest rate cut a Cup Day certainty

Pssst… want a tip for Cup Day? The release of the TD Securities-Melbourne Institute Monthly Inflation Gauge this morning has made it a dead-cert that the Reserve Bank will cut interest rates by 0.5% when it meets tomorrow afternoon.

Pssst… want a tip for Cup Day? The release of the TD Securities-Melbourne Institute Monthly Inflation Gauge this morning has made it a dead-cert that the Reserve Bank will cut interest rates by 0.5% when it meets tomorrow afternoon.

Falling fruit and vegetable prices have helped annual headline inflation fall below the 4% mark for the first time since January, with the gauge showing a 3.9% rise in headline inflation for the 12 months to 31 October.

In monthly terms, the gauge fell by 0.2% in October, following a 0.45 rise in September.

TD Securities senior strategist Joshua Williamson says the fall will see further rate cuts.

“If, as we expect, inflation keeps falling, the depths of the global recession and the weakness in the Australian economy could see rates eventually reach a low of 4%,” he says.

Most economists believe the RBA will follow last month’s shock 1% rate cut with a cut of 0.5% tomorrow, although there has been some speculation a cut of 0.75% is possible.

Westpac chief economist Bill Evans believes inflation has become a secondary issue for RBA Governor Glen Stevens in the wake of the global financial crisis.

“The way we see the RBA’s thinking at the moment is that they are focused on avoiding a recession. If the economy does lapse into recession then inflation will almost certainly collapse anyway.”

But as with any rate cut, the big question will be; will the banks pass the rate cut through to mortgage holders and business borrowers?

Given the Federal Government’s decision to give the banks a guarantee over deposits, Treasurer Wayne Swan will have plenty of ammunition to pile the pressure on lenders.