RBA Opens Door to Another Interest Rate Cut to Offset Strong Dollar

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By Vittorio Hernandez | February 26, 2013 11:23 AM EST

With the Reserve Bank of Australia (RBA) set to meet again in the next few days to make another overnight cash rate decision, the central bank hinted on Tuesday that it may cut the current 3 per cent key lending rate to offset the impact of the strong Australian currency.

The hint, made by RBA Assistant Governor Guy Debelle, is based on previous rate cut decisions that helped counter the negative impact of the Australian dollar's continued strength.

In the second half of 2012, the RBA sold Australian dollars directly to a foreign customer and held on to foreign currency it received to prevent an upward pressure on the Australian dollar. Analysts described that move as a form of passive intervention as opposed to the more active cutting of rates.

"To date in Australia, we have been able to counter the effects of the higher Australian dollar with lower interest rates. We still, obviously, retain scope to lower interest rates further, should the need arise, including to counterbalance the pressures of an elevated exchange rate," The Sydney Morning Herald quoted Mr Debelle's speech at the University of Adelaide Business School.

The Aussie dollar currently trades at 103 U.S. cents. It has breached the 100 cent mark in the past two years even if the country's terms of trade had gone down over the same time frame.

From November 2011 through December 2012, the RBA had cut the benchmark lending rate by 1.75 per cent, however, most of the local banks did not pass the rate cut in full but pocketed a portion of it.

The RBA official admitted that the central bank is cautious when making rate cut decisions because very large reductions could have a negative impact on the economy. He cited the experience of Canada, Hong Kong and Switzerland where policy decisions generated excess credit expansion or asset price inflation or imbalances in other parts of the national economy.

He added that while the RBA has cut substantially the overnight cash rate the past two years, the decision had less impact on mortgage rates because of higher bank funding costs. He added that despite the large influence of the cash rate on lending rates, other factors come into play such as credit risk premia, competitive pressures in the deposit market and changes in the mix of funding that banks use.

"Over the past five years, there has been quite a material change in a number of these factors, so that while changes in the cash rate are still the predominant determinant of changes in lending rates, the relationship between them is not one for one," Mr Debelle said.

Regardless of the RBA decision, analysts said the big four are under more pressure to cut their lending rates with the lenders registering profits from new mortgages at record-high levels in a decade.

"As a result of the rapid improvements in debt markets over the last six months, and a series of mortgage repricings, banks are now (profiting more( from originating a mortgage than any time previously," The Australian quoted UBS analyst Jonathan Mott.

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