Even with low rates, RBA signals more falls could come

The Reserve Bank had been signalling since it cut its cash rate to 3 per cent last December that it had room to go even lower if it judged that more stimulus was needed. It has now cut the rate by another quarter of a percentage point to 2.75 per cent and, importantly, signalled that rates could fall even further from this unprecedented low.

This was a close call for the Reserve, and there is not that much in the statement announcing the cut to suggest that it thinks its base scenario has weakened significantly. It sees the mining investment peaking towards the end of this year, and says there are signs that the non-mining economy is responding to earlier rate cuts and becoming more active.

It notes the recent benign inflation numbers put inflation back in the middle of its 2 per cent to 3 per cent target range, and there is no doubt that with inflation quiet, there was room for what might be a precautionary additional cut.

Data continues to be mixed, but the balance of it suggests that economic growth is threatening to fall below 3 per cent this year, and with that in prospect, a rate cut is justified.

Importantly, the Reserve also hints that it has room to cut rates even further. It had been noting that the inflation outlook afforded scope to ease the monetary settings, it said, and "at today's meeting the board decided to use some of that scope ... to encourage sustainable growth in the economy, consistent with achieving the inflation target".

That suggests, first, that not all of its "scope" has been used. It also suggests the Reserve thinks that, if anything, inflation is trending to the low side and becoming a signal of economic weakness.

The pressure is now on the big four banks to at least pass this rate cut on, and perhaps to go further.

As the March-half profit results from ANZ and Westpac in the past week have shown, bank margins are stable rather than expanding overall. Loan growth is also subdued. The banks are, however, boosting their profitability as they strip away costs and invest in new and more efficient ways of doing business, often IT-powered.

Bank shareholders are also benefiting because dividends and bank share prices have been rising, too, and bank net interest margins have been expanding in the retail banking divisions that provide home loans and small-to-medium-business loans. Margins are stable overall because the banks are seeing margins squeezed in their institutional banking businesses: there, they are competing on price to deliver loan funds to large corporations and institutions that are borrowing at record low interest rates in a global market that is awash with cash after northern hemisphere central quantitative easing programs.

The Reserve Bank has cut its cash rate by 2 percentage points since October 2011, and about 0.4 percentage points of that cut has been retained by the banks in less than complete pass-throughs.

They should at least pass this cut on, perhaps even more, although the opportunity to pass on more than a quarter or a percentage point was not picked up on Tuesday afternoon by the NAB, which announced a quarter of a percentage point cut. The NAB reports its March-half profit result on Thursday, but its declared guarantee to be the cheapest home loan provider of the big four banks expired at the end of last year, and it is still possible one of the others will break ranks if the tactical advantage is judged worthwhile.

One question is whether a home loan rate cut is what is really needed now. Home prices are already recovering after a slight dip last year. The place where more aggressive bank interest rate cuts is most needed is in the business sector, and in the industrial, retail and other non-mining business sectors in particular.

mmaiden@fairfaxmedia.com.au