RBA Rate Cut Does Little to Unlock Credit Market


“Rally to me,” said Glenn Stevens. And investors did.

The RBA rate cut WAS a full percentage point as we speculated yesterday. And it certainly did make a splash. Economists loved it. The critics praised it. And investors “huzzahed” the ASX 200 up nearly two percent on a day when the rest of the globe quaked in fear.

What has changed? The bank has shifted from being worried about inflation to being worried about recession. A credit crunch? Slowing global demand? Falling commodity prices? All those DO seem to add up to much slower growth.

“The recent deterioration in prospects for global growth,” the RBA released in a statement, “together with much more difficult market conditions even for creditworthy borrowers, now present the risk that demand and output could be significantly weaker than earlier expected. Should that occur, inflation would most likely fall faster than earlier forecast.”

But is the biggest RBA rate cut in 16 years more symbolic than anything? What will change in the real economy and the credit markets because of what the RBA has done? The big four banks did pass on a rate cut of 80 basis points to consumers. That’s a win for the battlers.

Will the RBA rate cut unlock the interbank lending market, though? The RBA board said it took careful note of movements in funding costs in wholesale markets,” and that, “an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers.” So credit is now cheaper. But is anyone selling? Banks might begin lending if they were sure it was safe to lend. But is it?

To the extent that Aussie banks fund domestic lending by borrowing from foreign banks, the lower rates don’t help either. The cut DOES help reduce the cost of all that debt Aussie consumer are carrying (160% of disposable income according to Dr. Steve Keen). But it doesn’t make the debt go away.

We made an error earlier this week when we said Australia had moved to guarantee bank deposits. That move has been made in the U.S. and Europe, but not yet in Australia. And according to Wayne Swan on Lateline last night, there’s probably no need to do so, since Australian banks are well regulated and well capitalised. Hmmmm.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. This rate cut was obviously for the banks, Swan pretty much gave them the green light to keep most of it – not that they would care what he said.

    By passing most of the cut onto the price of consumer credit, should we assume the banks are starting to get worried? After all, they make most of their money through lending rather than people’s savings. But I don’t see the population flocking to the banks in droves to take out million dollar loans to buy inflated property.

    And already the cut is doing its dirty work, the AUD is at a 5 year low against the USD. All this means is any money saved from the mortgage will be quickly spent on the rising costs of imports.

  2. This rate cut was really dumb. Now the Australian dollar is fiendishly losing value. Australian companies with imported inputs have come to a standstill and consumers are withdrawing money from the banks (correctly) anticipating hyperinflation.

  3. Three Wise Men? – 2008 and 1927


    “Federal Reserve Chairman Ben S. Bernanke push for the broadest coordinated interest-rate cut in history started with a weekend of telephone conversations with Jean-Claude Trichet [President of the European Central Bank, previously France’s chief central banker] and Mervyn King [Governor of the Bank of England].

    “Calling from his Washington office on Oct. 4 and Oct. 5, Bernanke broached the idea with Trichet, the European Central Bank president, and King, the Bank of England governor. The talks culminated Oct. 7 in a conference call where they privately hammered out details of the unprecedented move. Also on the line were central bank chiefs in Canada and Japan.

    “Twenty-four hours later, the plan came to fruition when policy makers announced half-point reductions aimed at easing the financial crisis” (Scott Lanman, Bernanke’s Push for Global Cut Began With Trichet, King Talks, bloomberg.com, October 9, 2008).


    “Had the situation continued, most European nations would have had to leave the gold standard. Given the complexities of the reparations situation, the United States would be dragged down with them in a major financial crisis. Accordingly, Secretary of the Treasury Andrew Mellon and Benjamin Strong eagerly accepted invitations from European central bankers to a conference on the question. In 1927 Montague Norman of the Bank of England, Hjalmar Schacht of the Reichsbank, and Charles Rist of the Bank of France met with their American counterparts. The situation might yet be saved, they argued, if the Federal Reserve cut its rediscount rate. Such an action would lower American interest rates in relation to those in Europe, and therefore attract funds to European banks. At the same time, low interest rates would encourage borrowing in America and stoke the speculative furnaces. Strong was unhappy about the latter probability, but in the end proved willing to further stimulate an already active American economy in order to save international stability. In 1927, the Federal Reserve lowered its discount rate from 4 to 3.5 percent.

    “Wall Street greeted the lowered rate. It meant businesses could borrow funds more easily, and so expand operations and profits. More important, it assured a continual flow of cheap credit for the call-money market. Member banks were able to borrow money from the Federal Reserve at 3.5 percent and then lend it as call money at 5 percent, making an easy profit of 1.5 percent. Thus, the international situation was resolved in such a way as to encourage speculation on Wall Street” (Robert Sobel, Panic on Wall Street, pp.360-361).

    “Adolph C. Millar, a dissenting member of the Federal Reserve Board, subsequently described this as ‘the greatest and boldest operation ever undertaken by the Federal Reserve System, and…[it] resulted in one of the most costly errors committed by it or any other banking system in the last 75 years’. The funds that the Federal Reserve made available were either invested in common stocks or (and more important) they came available to help finance the purchase of common stocks by others. So provided with funds, people rushed into the market. Perhaps the most widely read of all the interpretations of the period, that of Professor Lionel Robbins of the London School of Economics, concludes: ‘From that date, according to all the evidence, the situation got completely out of control'” (John Kenneth Galbraith, The Great Crash, pp.38-39).

  4. Post-Crisis Rally, Retracement and Major Rally

    The discount rate cut from 4% to 3.5%, in response to an international financial crisis, was effective on August 5, 1927 at the Federal Reserve Banks of Boston and New York. The Dow Jones closed lower on the day just as it did on October 8, 2008 after the interest rate cuts in response to the latest international financial crisis.

    It was not until seven days later, on August 12, 1927 that the Dow put in a financial-crisis bottom (177.13) that would eventually lead to the mania rally of the 1920s boom.

    From August 12, 1927 the Dow rallied 12.78%, over some seven week, to put in an interim high (199.78) on October 3, 1927.

    In the retracement – testing the low – the Dow fell 10.01% to close on October 22, 1927 to set the retracement bottom (179.78) for the major rally (112.02%) that peaked with a closing high (381.17) on September 3, 1929.

    This pattern of post-crisis rally – retracement – major rally occurred in 1990-1998 (long duration), 1998-2000 (short duration), 2002-2007 (long duration) and may repeat in 2007/2008-???? (short duration?).

    On October 11, 1990 the Dow put in a financial-crisis bottom (2365.10). In the post-crisis rally the Dow rose 11.50%, over some eleven weeks, to put in an interim closing high (2637.12) on December 26, 1990.

    In the retracement – testing the low – the Dow fell 6.30% to close on January 9, 1991 to set the retracement bottom (2470.30) for the major rally (278.02%) that peaked with a closing high (9338.19) on July 7, 1998.

    On August 31, 1998 the Dow put in a financial-crisis bottom (7539.64). In the post-crisis rally the Dow rose 8.15%, over some three week, to put in an interim closing high (8154.41) on September 23, 1998.

    In the retracement – testing the low – the Dow fell 5.25% to close on October 5, 1998 to set the retracement bottom (7726.24) for the major rally (51.73%) that peaked with a closing high (11,722.98) on January 14, 2000.

    On October 9, 2002 the Dow put in a financial-crisis bottom (7286.27). In the post-crisis rally the Dow rose 22.58%, over some seven weeks, to put in an interim closing high (8931.63) on November 27, 2002.

    In the retracement – testing the low – the Dow fell 15.76% to close on March 11, 2003 to set a retracement bottom (7524.06) for the major rally (88.26%) that peaked with a closing high (14,164.53) on October 9, 2007.

    The Dow Jones from January 11, 2000 to October 9, 2002 fell 37.85%. The Dow Jones from October 9, 2007 to October to October 9, 2008 has fallen 39.43%.

    In the above examples the post-crisis bottoms occurred twice in August and twice in October. August 2008 has passed will the post-crisis bottom once again occur in October?

    Yesterday in an article entitled “Dow and S&P 500 Capitulation Pre-Alert” (http://www.321gold.com/editorials/hoye/hoye100808.html) Bob Hoye suggested that we are close to a financial crisis bottom.


Leave a Reply

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au