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Signs that interest rates could fall -

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Signs that interest rates could fall

The World Today - Friday, 1 August , 2008 12:15:00

Reporter: Peter Ryan

ELEANOR HALL: And there are more signs of a weakening Australian economy this morning. A closely
watched manufacturing index out today is showing industry activity close to a three-year low.

That's on top of yesterday's news showing the weakest retail sales in more than a decade.

It's all being seen as evidence that the Reserve Bank's series of interest rate hikes is pushing
the economy towards recession.

I'm joined now by our business editor, Peter Ryan. So Peter what do these manufacturing figures

PETER RYAN: Well Eleanor, Australian manufacturing activity is now at a three-year low or close to
a three-year low as those high interest rates slow the economy. And this if from the Australian
Industry Group and Pricewaterhouse Coopers and it is a very closely watched manufacturing index.

And the reading is below a critical 50 point level which separates an expansion in the economy from
a contraction and this is for the second straight month. And it is also the weakest reading for the
survey which takes in about 200 companies since November 2005.

The AI Group's chief executive, Heather Ridout says there is no doubt that the economy is slowing
and the outlook for manufacturing is grim.

HEATHER RIDOUT: Clearly the industry is really responding to the weakness of housing, the weakness
of consumer expenditure that is really softening under the weight of the interest rate rises.

I think the uncertainty caused by the whole global credit crunch and the effect on confidence that
is having as well. And the higher dollar is clearly putting a major drain on the import
competitiveness of the industry and continuing to constrict our export performance even though it
has picked up a little, it is fairly narrowly centrally based.

ELEANOR HALL: That's Heather Ridout, chief executive of the Australian Industry Group.

Peter, there is also new evidence today that Australia's corporate sector is feeling the heat from
the credit crisis. What can you tell us about that?

PETER RYAN: Yes, as we have seen with the National Australia Bank and the ANZ Bank this week, the
financial services sector is hurting very badly.

Today Australia's second biggest car and home insurer Suncorp Limited shocked the market with a
profit warning. They are saying that because of the global credit crisis, its annual profit will
halve to around $500-million. That is down from a billion dollars.

You would think they would be getting conditioned about this but investors still hate surprises and
they sent Suncorp shares packing and they went down as much as 18 per cent.

Suncorp like the NAB and the ANZ says its underlying business is strong but added that its level of
non-performing loans was expected to rise and critically its wealth management business, where they
have been making a lot of their money, has been significantly impact by the downturn in investment

And by the way the overall share market is weaker today, down around 1.3 per cent. There have been
heavy losses for the banks again. The Commonwealth Bank down 1.5 per cent. The NAB one per cent;
but Westpac and St George are both down around three per cent today.

ELEANOR HALL: Given this sort of corporate news and these sorts of economic figures, is there a
view that the Reserve Bank has gone too far with its interest rates strategy?

PETER RYAN: Yes the strategy of hiking interest rates has all been designed to pull back consumer
demand, stop people using the equity in their homes as a huge ATM machines and to ultimately tame
inflation. That appears to be working but it is coming at a cost to families and small business.

Life is much tougher than it was in December 2001 when rates were just at 4.25 per cent. We've now
had 12 rate hikes in a row. We've had two this year, in February and March and rates are now three
per cent higher at 7.25 per cent.

And of course, this year the banks have regularly been raising their rates independent of the
Reserve Bank to cover the credit crisis and the higher cost of money.

And importantly, the pain has been a lot sharper for those households that thought they were being
quite strategic in locking in rates at five- and three-year fixed terms and they are now moving
into a very expensive environment.

ELEANOR HALL: What is the likelihood that the Reserve Bank board will now cut rates this year?

PETER RYAN: It seems very possible that when the Reserve Bank meets on Tuesday, the first Tuesday
of the month, that no action will be expected, but these days we get a lot more information from
the Reserve Bank. They now publish their reasons for not making a decision. Previously they would
only comment if they put rates up or put rates down.

And so economists will have quite a few tea leaves to read in looking for changed language. Often
it is very subtle but we've noticed in recent statements that the language has been much more

Some pundits have been tipping September for a rates cut. That is seen by other economists as being
too early. Perhaps the RBA might wait, manage expectations and do something by the end of the year.

And this time last week we saw some similar action in New Zealand where inflation is high and it is
going to be remaining high but they have cut rates quite significantly by half of one per cent
simply because the economy is almost in recession.

ELEANOR HALL: Now you mentioned that the banks have hiking up their rates independently of the
Reserve Bank. Even if the Reserve board does cut rates, will the banks necessarily reduce their
rates in line?

PETER RYAN: Well that is a big question and Kevin Rudd has commented on this without questioning
what banks should be doing in a free market. But it highlights what many see as a major disconnect
these days. On the one hand we have the Reserve Bank using interest rates to manage the economy and
to bring down inflation but banks have been facing increasingly narrow margins because of the
higher cost of money in the credit crisis.

But you would imagine that there would be a high level of political pressure. If any downwards
movement by the Reserve Bank was effectively neutralised by an independent hike by the Reserve
Bank, banking chiefs have said that they will keep hiking rates independently as long as money is
expensive, but at the same time they have said that when their profits return, they would consider
bringing rates down.

ELEANOR HALL: Banks never have high enough profits do they Peter?

PETER RYAN: That's right, they can never be high enough and it is true to say that banks would see
themselves as having a greater responsibility to shareholders.

ELEANOR HALL: Just quickly, more bad news out of the United States this morning too?

PETER RYAN: Yes, there is now more fresh concern about the state of the US economy after a pretty
disappointing set of growth figures and the US, the world's biggest economy grew by just 1.9 per
cent in the three months to July. That disappointed the share market but it is seen as confirmation
that the American economy continues to contract and it adds to the case that the United States
might already be in recession.

ELEANOR HALL: Business editor, Peter Ryan, thank you.