IT’S time for the Reserve Bank to stump up on Tuesday with an interest rate cut to kick-start the nation.

The Australian economy has been a one trick pony for much of the past decade, but our prized runner – the mining industry – just turned lame. It is time for the Reserve Bank to give the other parts of the economy  retail, manufacturing, services and construction  a giddy up this Tuesday.

It’s a close call – given the Reserve Bank has already cut interest rates 1.5 percentage points over the past year – but another rate cut at 2.30pm looks like the favourite.

Another cut would take the official cash rate to 3 per cent – the lowest it ever went during the depth of the global financial crisis in 2009. But the actual interest rates people pay today are still higher than back then, given the banks have failed to pass on all cuts in full. And the Australian dollar, which was as low as US70 cents in 2009 remains stubbornly high at $US103.
When the commodity price and investment boom was cranking up, the Reserve was happy to make room for it by clamping down on other parts of the economy. Manufacturing, retailing and home construction have taken a belting

But the commodity price boom that saved Australia from recession –  not least by filling government coffers with the fiscal fire power to combat the financial crisis with stimulus – is over.

Commodity prices are still historically high, but have fallen and are not expected to recapture their previous highs. Meanwhile, the labour intensive investment phase of the boom is nearing an end sooner than expected. The final phase – the export boom – will soon come on line, but will require fewer workers than it did to build all the new roads, rail and processing capacity. Machines, aided by skeleton staff, will load the boats to China.

Now the boom is ending there is less pressure on the economy’s productive capacity and hence inflation. The jobs market has cooled. The jobless rate has spiked up to 5.4 per cent and may spike higher yet. The risk of a wages fuelled breakout in inflation is lower.

So with our prize-winning horse on the way out, it’s time to give the others a go by dropping interest rates. Lower interest rates help to stimulate activity by making it cheaper to borrow.

Usually, as commodity prices fall, you would also expect a falling Australian dollar to help stimulate the economy by making our exports cheaper for foreigners to buy.

But these are anything but usual times.

Investment flows from overseas investors are stopping the Aussie dollar from falling. Low interest rates in the developed world – particularly the US and Japan where interest rates are zero – have made the return on domestic savings in those countries very low. Investors looking for higher yielding assets are looking to Australia where the return on investments is higher. They are buying up Australian dollars and pushing up their value.

The Reserve Bank can’t stop this altogether – not unless it dropped interest rates to zero too – but it can offset some of the negative impact of a high Australian dollar with lower lending rates.

The question for Tuesday’s meeting is, has enough been done already to stimulate non-mining parts of the economy?

There are tentative signs previous interest rate cuts are helping. New home approvals jumped last month, but largely on the back of apartments. Building of free standing new homes remains in the doldrums.

House prices – which had been recovering after years of going nowhere much – fell 1 per cent last month.

Another reason for leaving interest rates on hold would be concern about recent figures showing a pick up in inflation. Getting a clear picture is harder because of the impact of the carbon tax. But core inflation, even at 2.5 per cent, remains within the Reserve’s comfort zone. Looking forward, a higher dollar and higher jobless rate makes a future breakout in inflation less of a risk.

The greater risk is that the interest rate sensitive and non-mining parts of the economy take longer to pick themselves up off the floor as the mining boom fades.

So it’s an interest rate cut, by a nose.

Read more: http://www.news.com.au/realestate/experts/giddy-up-reserve-bank-and-give-us-an-interest-rate-cut/story-fnda0j6w-1226509802067#ixzz2BJHrCwMu