Further interest rate cuts a safe bet as the world continues to feel the effects of the GFC

While the rest of the developed world teeters on the brink of a global recession that some experts suggest could have economic ramifications for at least another five years, Australia has one of the best weapons at its disposal to protect our local economy – the ability to cut interest rates.

Recently Westpac retail banking head Rob Coombe warned that the European debt crisis currently playing out was the next stage in the continuing aftermath of the GFC.

“Based on historical experience and the high level of sovereign debt, we can reasonably expect that recovery in the US and most economies in Europe will be slow, painful and involve social and political upheaval,” Mr Coombe said.

“We expect the risk of sovereign default in Europe to be ongoing and to create continuing volatility in debt and equity markets based on fear.

“These conditions are likely to last for a number of years even though the crisis is already close to four years old. The problem may persist for three to five years more, making the whole event nearly a decade in length.”

The problems in Europe are serious.

Coombe believes the outlook for Europe to be more dire than in the US, where he feels they have the ability to make a faster and more sustainable recovery.

“It’s a very difficult hole to dig yourself out of, because fiscal stimulus is not an available option because of the government debt, and most of these countries don’t have the monetary policy tools,” he said.

“I think the US has probably more chance to get itself out, and at a quicker rate than Europe. The US culture has more of a tendency to put its issues on the table and deal with their difficulties, and their population is growing.

“Europe doesn’t have that, and that has weakened its competitiveness, and I think the euro is going to come under pressure.”

Optimistically, Coombe says Australia has a strong safeguard for our local economy in the Reserve Bank’s potential to cut interest rates, which he describes as the best “tool in the kit bag”.

More rate cuts to come?

An article in The Australian reports that Westpac expects the RBA to slash interest rates by up to 100 basis points over the next year, with its recent 25 basis point cut on Cup Day signalling the beginning of things to come.

Although we are in better financial shape than many of our overseas counterparts, Coombe acknowledges that consumer uncertainty has put the brakes on future growth to some degree, with Westpac’s surveys indicating that market sentiment is at its worst level since the 1990s recession.

Mr Coombe said the poor sentiment was at risk of invoking the “paradox of thrift” theory, in which consumers contributed to an economic downturn by saving too much, as more of us choose to park our money in retail deposits. In fact, we are currently saving at a higher rate than we have for two decades.

“As opposed to the US and Europe, where a low-interest-rate environment reduced the potential effectiveness of monetary policy, a 4.75 cash rate provides the RBA with plenty of firepower to ensure the economy doesn’t collapse into the throes of the paradox of thrift,” he said.

“The significant reduction of interest rates is the strongest tool to have in the kit bag” at this point in the economic cycle.

So you may not have backed the winning horse on Cup Day, but mortgage holders look set to come out on top as the RBA does its darnedest to keep Australia’s economy on track.


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