Rate cut reflects dollar dilemma

The Reserve Bank of Australia's (RBA) move to cut interest rates last Tuesday surprised fewer than the media suggested, but still gave the market the fundamental backing to sustain its recent breakout.

Although the move was somewhat predictable as a means of curtailing the high Australian dollar, it must have been a surprise to the four big banks.

It took three days for NAB, CBA and WBC to act, with cuts of 0.20 per cent, 0.20 per cent and 0.18 per cent, respectively. ANZ looks like it is waiting until its monthly interest rate meeting on Friday to announce its position. One just wonders how much the banks profit per day when they delay an interest rate cut?

The RBA attempted to avoid directly relating the rate cut to the high $A, however, it did mention that the dollar had remained higher than previously expected and that it was appropriate for policy to be more accommodative to strengthen non-resource demand.

In justifying its decision, the RBA board listed a softer outlook on world growth, an uncertain outlook in China and the fall in the terms of trade. They also noted the risk to the outlook was still to the downside.

The final point was the most interesting when you take into account that at the September RBA meeting conditions were similar, if not worse, especially on the global outlook and considering that none of the world's four major central banks had announced their stimulus programs, which have since calmed financial markets.

The question now is, will the RBA follow the 'bazooka' stimulus approach and cut rates again in November? The answer is likely yes, and if not, then probably in December.

Although mortgaged households breathe a sigh of relief - even if it is a smaller sigh than it should be with the banks not passing on the full cut - are these cuts going to filter through to the economy and specifically the retail sector? Or will it be used to reduce debt or held as savings?

If the latter is the case, has the effect of rate cuts been lost as a tool for government policy? It is ineffective unless there is a demand for credit and increased borrowings.

To quote Alan Kohler on the topic of manipulation of the price of credit when it is not in demand - it is "like manipulating the price of beef at a vegetarian's picnic".

Yet as the market makes new highs for the past 12 months with investors scampering from deposit accounts into high yielding stocks, it can be easy to become a little blasé enjoying watching your stock holdings rise (at last).

Without trying to put too much of a dampener on it, what has actually had to happen for this to positive run to eventuate?

Believe it or not, the world is in such a financial mess that governments are trying to stimulate stock markets higher in the hope that wealth filters down into the rest of their economies. In Australia's case, the RBA is doing it through interest rate cuts.

So enjoy this rally, but keep in the back of your mind the weak state of world economies and be vigilant.

Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time.