Banks Play Ducks And Drakes With Reserve's Rate Cut

Sydney Morning Herald

Wednesday November 5, 2008

Elizabeth Knight

The decision by the Reserve Bank to lower interest rates by three quarters of a percentage point was a bookmaker's delight, in much the same way as the four-legged Viewed which was not the favourite to win the Melbourne Cup.

And while the Cup has traditionally been the race that stopped the nation, there would have been many more Australians sweating on the outcome of the deliberations by the Reserve's boss, Glenn Stevens, and the bank's board than there were watching what took place at Flemington. Stevens certainly did not disappoint.

But moving the official rate is only one part of the equation. If we, the borrowers or the businesses that are paying interest rates, are to be the happy recipients of the lower costs of funds, we need the banks which lend to us to adjust their rates down.

And yesterday the waters were pretty murky.

The trouble is that reactions by the banks to changes to official rates in these unusual times has become a game of ducks and drakes. It is all about who is the first mover, when to follow and by how much.

The Commonwealth Bank came out within minutes of the announcement and cut its standard variable rate by 58 basis points, thereby setting the benchmark. It explained that it did not pass on the full rate cut because of the significant increase in all three elements of its cost of funding over the past few weeks.

But debt analysts agree that the cost of offshore wholesale funding has been coming down recently.

It's more likely that the funding costs from retail deposits has been the biggest drag on the interest rate margin for banks because they have been competing vigorously to attract deposits.

The other banks did not reveal their intentions last night. Some might follow the Commonwealth and scrimp on a full 75 basis point cut. Others might win themselves some public relations brownie points by being a bit more generous with their initial cut.

When the Reserve cut rates last month by a completely unexpected 100 basis points (1 percentage point) it caught the whole market by surprise. All banks initially reduced the rate by less and dribbled out some additional reductions in the following weeks.

All of them would dearly love to just take advantage of the cut in wholesale funding delivered by the RBA and pass nothing on - thereby improving their interest rate margin and profitability.

But there is far too much pressure from the community and the Federal Government for the banks to try that trick.

The Treasurer, Wayne Swan, said he hoped the banks would pass on as much as possible of the cut. The Government's view is that it has given the banks a free kick by guaranteeing deposits up to $1 million and their interbank lending on world financial markets.

It expects them to behave themselves and pass some of this largesse back to the community in the form of lower rates. They will, but are trying to clip a bit off as it passes through the vault.

Swan is desperately hoping that this monetary stimulus will save Australia from the recession that most of the western world has fallen into. The Reserve Bank is clearly coming to the party. Most were expecting a 50 basis point cut yesterday but it seems Stevens believes more radical intervention is needed in these almost unprecedented times.

Last Thursday night at the Business Council of Australia's dinner, attended by most of the country's financial business and powerbrokers, Stevens was seated next to the chief executive of David Jones, Mark McInnes, who would have undoubtedly have been pushing the recession panic button pretty hard.

Over the weekend, press reports made it abundantly clear that what has been cast as a short-term gradual decline in Chinese growth is fast becoming a more rapid deceleration, as local Chinese steel makers are closing factories - and the spot price of iron ore is tanking.

The resources sector - or more particularly the iron ore and coal producers - were meant to be saving our economy from falling into negative growth. But this safety net appears to be developing a hole.

Attempts by the Government to provide fiscal stimulus by throwing money at lower and middle income earners may have a mixed outcome.

Surveys of consumers have indicated that most of this money will be used to repay debt rather than be spent on consumer goods.

The same may be true of changes in interest rates with borrowers using the fall in rates to repay mortgages faster.

© 2008 Sydney Morning Herald

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