Surprise rate cut extends stocks rally

THE sharemarket jumped to life after the Reserve Bank cut the cash rate by more than expected yesterday.

By InvestSMART · 2 May 2012

By InvestSMART ·
2 May 2012

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THE sharemarket jumped to life after the Reserve Bank cut the cash rate by more than expected yesterday.

The surprise 50-basis-point cut, which took the official rate to 3.75 per cent, the lowest since early 2010, helped to extend a six-week rally on the S&P/ASX 200 Index, which has climbed

7.2 per cent, or 302 points.

The Australian dollar was an early casualty, quickly dropping from US104? to US103.2? on the news, and the yield on the 10-year government bond fell to its lowest in 60 years.

The S&P/ASX 200 Index closed up 32.9 points, or

0.7 per cent, at 4429.5.

Economists said the central bank was now clearly pursuing higher inflation, and that the surprise rate cut was likely to be followed by another one in coming months.

"Having cut rates so aggressively, the RBA is clearly targeting growth and if the data flow remains weak, another cut will happen," said National Australia Bank chief economist Alan Oster. "June is a possibility."

It's a very different situation from that in the

US, where Nobel Prize-winning economist Paul Krugman slammed members of the US Federal Reserve board yesterday for refusing to generate more inflation as a means of increasing employment.

In the past year, annual inflation in the US has been at roughly 2.7 per cent.

Mr Krugman said that, with millions of Americans out of work, US policymakers should tolerate inflation of

3 to 4 per cent to kick the economy to life.

"We have had a massive failure of our political system that has come to accept that 8 per cent unemployment is the new normal and there is nothing that can be done," he said. "We're in a low-key version of the Great Depression."

Back in Australia, Bank of Queensland appeared to be the first bank out of the blocks to pass on some of the RBA's rate cut, promising to lower its standard variable home loan rate by 35 basis points to

7.11 per cent, from May 11.

For the next couple of weeks all eyes will now be on the big four banks to see how they will respond.

"We expect ANZ's decision will be made first this Friday, announcing around 40 basis points [worth] of cuts," said Annette Beacher, head of Asia-Pacific Research at TD Securities.

"The other banks are expected to pass on

around 35 basis points,

citing elevated funding costs."

Shares in Woodside Petroleum were up $1.28 at $36.20 after it sealed a

$2 billion deal to sell part of its stake in the proposed Browse LNG Development to Japan Australia LNG.

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Frequently Asked Questions about this Article…

What was in the Reserve Bank's surprise rate cut and how did markets react?

The RBA surprised markets with a 50‑basis‑point cut, taking the cash rate to 3.75% (the lowest since early 2010). The news extended a six‑week rally in the S&P/ASX 200 (up about 7.2% over that period), the index closed up 32.9 points at 4429.5, the Australian dollar weakened and the 10‑year government bond yield fell to its lowest level in about 60 years.

How might the RBA's surprise cut affect everyday investors and the stock market?

Lower official rates tend to support share prices by making borrowing cheaper and boosting growth expectations — the article notes the ASX 200 rallied after the cut. For investors this can mean stronger equity markets, lower bond yields and potential shifts in currency and sector performance (for example, banks and resource stocks attracted attention).

Will Australian banks pass the RBA rate cut on to mortgage holders?

Some banks are already moving. Bank of Queensland said it would lower its standard variable home loan rate by 35 basis points to 7.11% from May 11. Analysts in the article expected the big four to pass on around 35 basis points (with ANZ possibly announcing about 40 basis points), though elevated funding costs could affect how much each bank passes through.

What should mortgage borrowers expect after this RBA cut?

Borrowers can reasonably expect some lenders to reduce variable mortgage rates, as shown by Bank of Queensland's 35‑basis‑point move. However, the size and timing of cuts will vary by bank — the big four were expected to announce cuts of roughly 35–40 basis points in the weeks after the RBA decision.

How did the Australian dollar and bond market respond to the rate cut?

The Australian dollar weakened following the announcement (moving from roughly US$1.04 to about US$1.032 in early trading), and the yield on the 10‑year government bond dropped to its lowest level in around 60 years, reflecting lower interest rate expectations.

Is another RBA rate cut likely and when could it happen?

Economists quoted in the article said the RBA appears to be targeting higher inflation and another cut is likely in coming months. National Australia Bank chief economist Alan Oster said another cut could happen if data remain weak and suggested June was a possibility.

How did individual companies react—what happened with Woodside Petroleum?

Woodside Petroleum shares rose after it sealed a roughly $2 billion deal to sell part of its stake in the proposed Browse LNG development to Japan Australia LNG. The stock was up $1.28 at $36.20 on the news.

What short‑term things should investors watch after the RBA's surprise cut?

Keep an eye on bank rate announcements (how much of the cut they pass on), upcoming economic data that could influence further RBA moves, movements in the ASX 200 and sector performance, yields on government bonds, and currency swings in the Australian dollar — all were highlighted as immediate market focal points in the article.