THE DISTILLERY: Cut copy

Jotters debate the size of today's likely cash rate cut, while others discuss the implications of Brambles' Recall sale suspension.

You can pencil in an interest rate cut from the Reserve Bank today, according to the market, with an almost four-out-of-five chance of a 50 basis point reduction. Our business commentators are far less certain. In their view, the domestic economy is not weak enough, nor is Europe’s total demise assured. However, the capital raising by Brambles yesterday has rekindled memories of the global financial crisis, where Australian corporates raised huge amounts of money from the market while they could.

Firstly, The Sydney Morning Herald’s Jessica Irvine can’t help but notice the gulf between the 80 per cent chance the financial markets are pricing for a 50 basis point cut, and the instinct of market economists. Of those economists, half expect a 25 basis point cut, a little less tip rates to remain on hold, and a minority of European bears anticipate a 50 basis point cut.

"Going into this morning's meeting, the average standard variable mortgage interest rate of Australia's big four banks is about 7 per cent, only a touch below its historical average of 7.5 per cent. With economic growth returning to trend and inflation in the target band, that is not an unreasonable place for interest rates to be. Of course, interest rates feed through to the economy with a lag, and what really matters is where the Reserve expects the economy to be a year from now. And really, that's anyone's guess. A 50 basis point cut would run the risk of looking like a panic move. Some may see it as an admission the bank has been completely behind the ball on interest rate cuts. Consumers may interpret it as a portent of something much worse in Europe.”

Indeed, Irvine’s colleague Michael Pascoe laid out the case yesterday against a 50 basis point cut, arguing that such calls are symptomatic of our tendency, as Australians, to whinge.

"Hopefully the RBA board has a little more perspective. Another 50-point cut shouldn't be on the agenda tomorrow. Maybe 25 points, given what we now know of the federal budget, but maybe not as most of the calls for greater stimulus are based on fears of what might happen rather than what is happening. It would be much easier for the RBA to make an informed decision if tomorrow's meeting was adjourned until the weekend, giving it the March quarter national accounts, May labour force, April housing finance and building approvals, plus a bunch of key Chinese economic statistics and some further US numbers to play with. But based on what's in front of them, the Australian economy is a long way from the crisis mode some corporate types and commentators seem to be suggesting, let alone the European level of financial uncertainty that one survey suggests Australians are feeling. And, contrary to what Melburnians perceive around AFL grand final time, neither the nation or the world revolves around Victoria. It's just one element of the national mix.”

Business Spectator’s Stephen Bartholomeusz is inexplicably the only commentator to suggest that the mitigating impact that the big four banks had on the last interest rate cut in May might be something the Reserve Bank will consider in June.

"There are a range of factors that will give the RBA board pause for serious thought about whether or not to follow May’s 50 basis point rate reduction with a further reduction. One of the more obvious is that it knows from the May experience, when the banks declined to pass through the full 50 basis points (which the RBA anticipated and built into the decision to cut by 50 basis points rather than its conventional 25 basis points) and from its continuing engagement with the major banks that they would almost certainly again retain a proportion of any official rate cut. The impact of a 25 basis point reduction in the cash rate would be muted if the banks, still experiencing pressure on their net interest margins from the competition for deposits, hung onto five or ten basis points. That means the RBA, if it wants to generate some meaningful stimulus, would need to seriously contemplate another 50 basis point cut.”

Meanwhile, The Australian Financial Review’s Chanticleer columnist Tony Boyd is one of two commentators to spot the link between the Reserve Bank’s decision today and the suspended sale of Brambles’ US document management business, Recall, and subsequent capital raising.

"Market watchers who survived the global financial crisis would have felt a strong sense of dj vu yesterday when Brambles did an accelerated rights issue in a falling market to prop up its balance sheet in readiness for trouble. Expect to see more of this over the next few months as companies opt for the conservative option of raising equity in response to a blowout in balance sheet ratios caused by weaker cash flows. The weaker cash flows are a reflection of the economic conditions that are obvious from the latest run of data across the economy. The weaker data will be fed into the decision-making at the Reserve Bank of Australia board today. The RBA will have every reason to move rates down by 25 basis points to 3.5 per cent given what is happening in Europe and the likelihood that this political impasse will continue for several months. The loss of momentum in the US economy will also be a factor influencing a rate cut that is likely to be the second of many in 2012.”

The second commentator to spot that link is The Australian’s John Durie.

"The suspension of the Brambles Recall sale was widely flagged and triggered a $448 million rights issue to replace the underwritten dividend reinvestment program to help finance the $1.3 billion IFCO acquisition two years ago. This was opportunistic timing from…(chief executive) Tom Gorman because it is far better to raise the cash when you can, rather than walk the gauntlet of a DRP underwrite in a volatile market. At the end, there were just two private equity bidders left. Both had not only cut the terms of their offer but started piling on conditions to transfer risk from themselves to Gorman. He politely declined, leaving a disappointing but not disastrous outcome.”

Notice how Durie makes a distinction between what Gorman can do now and when markets become "volatile”. We’re already in volatile times by historical standards – the VIX index isn’t far off the 30 point mark, where investors really panic – but the tone of our commentators is shifting as they seriously recall the depths of the GFC.

Still on interest rates, The Sydney Morning Herald’s Ian Verrender suggests that a 50 basis point reduction by the RBA would significantly reduce the premium that Australian government bonds are currently trading at compared to US treasuries, which would weaken the Australian dollar. However, the writer doesn’t explicitly state that’s what the central bank will cut by this afternoon, only that a cut of some description should come.

In other economic news, The Age’s Eric Johnston raises questions for ratings agency Standard & Poor’s in response to its suggestion that Australia’s AAA-credit rating would be put at risk if the federal government dropped its budget surplus plans during another global downturn. The story begins with the phrase "Economists have expressed surprise” – how often it is that commentaries about the ratings agencies start with bewilderment.

Speaking of a global downturn, however, The Australian Financial Review’s Philip Baker takes a look at global bond yields and concludes that coordinated global action is required, but the institutions once capable of leading such a move aren’t quite in rude health. Meanwhile, The Age’s economics editor Tim Colebatch laments the surplus in European politicians and the deficit in statesmen.

In other news, The Australian Financial Review’s Matthew Stevens continues his analysis of the persistent industrial relations dispute in the Bowen Basin. The Australian’s Paul Garvey looks at the persistently positive sentiment for LNG in Asia.

And finally, Fairfax’s Insider columnist Ian McIlwraith follows the wind down of Keybridge Capital and finds another investor coming in to rival Nicholas Bolton – you might remember he shot to fame with the near-death experience at BrisConnections.

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