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Decision day: Rate cut on the cards

The majority of economists are tipping a rate cut today, with the consensus view that the Reserve Bank of Australia (RBA) will cut the official cash rate by 0.25% down to 3%, on concerns of slowing domestic growth. Some experts believe the RBA could even go as far as cutting rates by 0.5%.

Many had expected the RBA to cut rates in October, but the RBA didn’t oblige, and since then we’ve had a slew of negative data, including a slowdown in planned mining activity and continuing weakness in housing, manufacturing and retail industries. That suggests a cut is more likely today.

A reduction in rates should drive some growth in the economy before Christmas and get consumers to spend, but there is some argument that 0.25% may not be enough to kick-start a recovery.

Related: Can the RBA save Christmas?

Stephen Koukoulas of MarketEconomics has slammed the RBA, suggesting it has been behind the eight-ball all year, and says “…the official cash rate should be ending 2012 around 2.5%.” He adds “Right through 2012 the RBA has been as slow as a wet weekend to recognise and then acknowledge the pressures in the economy, most of which are dampening growth, limiting job creation and keeping inflation well and truly in check.”

The current cash rate is currently at 3.25% and the RBA has cut rates by 1.5% over the last 12 months, with cuts coming in November 2011 (0.25%), December 2011 (0.25%), May 2012 (0.5%), June (0.25%) and October (0.25%). Those cuts appear to have had little effect on our economy so far. Despite a temporary fall below US$1 following the May rate cut, the Australian dollar soon rose back over parity, and has stayed there since June. That hasn’t been good news for our manufacturers and exporters.

Some economists also believe that consumers have become impervious to rate cuts, and are refusing to spend. The Economist reports that Japan has found out in recent years that despite lowering rates to near 0%, its population has kept their hands in their pockets and their cash under the bed.

A cut should be good news for mortgage holders, but as we’ve seen the banks unwilling to pass on the full cut, there’s a strong likelihood of that happening again.

Christopher Joye, writing in the Australian Financial Review, said today “Banks are not passing on the full cut, passing on 1.15% of the 1.5% in RBA cuts to mortgage borrowers. In contrast, deposit rates have dropped by 1.3%, showing that banks margins are improving.” ANZ Bank (ASX: ANZ), Commonwealth Bank (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) have consistently cited deteriorating margins for the reason to not pass on the full rate cut.

The RBA has a difficult decision to make. A 0.25% cut could see a maximum of 0.2% passed on by the banks (as they did in October), so the RBA will need to take that into account and decide if 0.2% will be enough to generate some growth.

Foolish takeaway

The cards point to a rate cut of 0.25% today, taking the official cash rate to 3%, although we could see the RBA take a 0.5% cut. Leaving the rate steady is likely to dampen the hopes of many, including retailers, homeowners and companies in the building and construction sectors. Let’s hope the RBA gives them some Christmas cheer.

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Motley Fool writer/analyst Mike King doesn’t own shares in any company mentioned. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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