Nothing much surprises me these days - except this!

October 7th, 2008

by Peter Spann, CEO, Freeman Fox - 7 October 2008

The Reserve Bank today announced it was cutting the cash rate target by a mammoth 1% lowering it to 6%.  What a surprise!

If fully passed on (which is unlikely) this would mean a $208 monthly cut on a $300,000 mortgage, and $276 on a $400,000 loan.

The major banks -- Commonwealth, Westpac, NAB, ANZ and St George Bank -- have suggested they are not in a position to pass on the full benefit of a cut because of their cost of funding from the wholesale money markets.

At 4.09pm the Dow Jones news wire reported that "Westpac was the first to move after RBA's stunning 100 basis point cut to official cash rate; Westpac to pass on 80 basis points of that cut to borrowers.   Still no word from major rivals on moves, but with Westpac moving by 80 points, expect others to cut by a similar amount."

Recent hits to the stock markets may have put the Reserve under added pressure to slash rates by more than the predicted 0.5 percentage points.

The last time the RBA slashed rates by 0.5 percentage points was in the wake of the September 11, 2001 terrorist attacks on the US but it also resorted to full 1 percentage point cuts to rejuvenate the economy during the last recession in 1992.

The RBA stated conditions in international financial markets taking a significant turn for the worse, falls in international share markets, and the likely difficulty of financing around the world for the foreseeable future, weakening economic activity and a "material change in the balance of risks" as their reasons for considering the rate cut and went on to say "Having weighed these considerations, the Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers. The Board does not, however, regard that movement as establishing a pattern for future decisions".

RBA Governor Glenn Stevens said lowering the cash rate to 6 percent represents an effort to help shield the Australian economy from the global credit crisis.

Brian Redican, Division Director, Economic Research Division, Macquarie Group said "Many central banks have attempted to make a distinction between their liquidity support operations, which are designed to address the credit problems, and interest rate policy which is directed at targeting growth and inflation.  But it is increasingly clear that the liquidity support operations haven't succeeded in halting the credit crisis and it is also apparent that the credit problems are increasingly spilling over into the real economy.  The RBA's decision today highlights that it is one of the first central banks to recognise the shift in momentum, but we suspect that it will be quickly followed by many other central banks slashing interest rates over the next few weeks and months."

He goes on to say, "Whether global monetary easing is co-ordinated or unco-ordinated is unclear.  But it is coming."   And this would be GOOD news for investors.

The Australian Share market reacted instantly and dramatically. By 10am the market was down over 2% and got down to over 3% before the announcement but the initial shock was replaced by a rapid positive reaction.  By 3pm NSW time the market had jumped up over 4% from its low to be up by about 1.5% on its close yesterday. 

Banks and financials jumped up but so did BHP, and takeover target RIO. 

Just about everybody has been stunned by this massive move by the RBA.  Of course most commentators are very positive but some say the RBA has over reacted.

It is a startling attempt by the RBA to open up the purse strings, get cash flowing again, stimulate the economy and relieve pressure on struggling home owners who have, through no fault of their own been bearing the brunt of the credit crisis. 

"The recent evolution of the credit crisis presents a serious threat to the Australian economy," Brian Redican, a senior economist at Macquarie Group Ltd. in Sydney, said ahead of today's decision, "The Reserve Bank's easing cycle is likely to step up a gear."

Waning consumer spending and confidence is being partially offset by a China-driven mining boom. Soaring coal and iron ore exports helped generate a trade surplus in August of A$1.36 billion, the second-largest windfall on record.

Inflation accelerated to 4.5 percent in the second quarter and is forecast by the central bank to peak at 5 percent later this year before slowing back within the bank's target range in 2010.

We expect continued volatility in the Australian share market until the full impact of the US bail out comes on stream and markets are confident there is not going to be any more bad news.  This could take some time.  Regardless I would like to repeat my assertion that current low prices of quality shares means good news for long term investors. 

Most shares and hence most managed funds are down considerably and this has prompted some investors to be shy.  While conservative investors should probably be in cash people with long term investing horizons (7 years plus) could actually benefit significantly by the current turmoil in markets by buying at low prices. 

You have to go back to the beginning of 2006 to find the All Ordinaries Index this low.  CBA is at its cheapest since that time, NAB and MQG haven’t been this cheap since 2003, BHP is at its cheapest for over a year and LLC is lower than it was in 2004. 

Freeman Fox Managed Funds have been performing well despite the market volatility with  GENERATOR™ increased its NTA by 2.86c in August after paying a 3.11c per unit distribution in June, MAXIMISER™ increasing in value over 3% between July and August, and EMERGENT™ up 5.84% since inception.  We believe an investment in these funds could be a wise idea for people who have more than $2,000 to invest with a medium to long term investing view who wish diversification in the portfolio and exposure to quality fund managers.

See my Special Reports "Fortune Favours the Brave"  and "The World Has Changed and Investing has Changed with It" on adapting your investing to the new world growth investments.  

Please contact Freeman Fox on 1800 000 369 for more information.

www.freemanfox.com.au