3 more rate cuts to come

Mr Bill Evans, the long-serving chief economist at Westpac (ASX: WBC), recently forecast three more rate cuts by the Reserve Bank of Australia (RBA) to occur by March 2014, with the first of these to come at the upcoming August meeting.

With the first Tuesday in August just over a week away now, a quick review of some of the factors which might sway the RBA board’s decision to cut seems in order.

Australia’s economy is struggling

The Australian Bureau of Statistics (ABS) released figures for the Consumer Price Index (CPI) this week and they showed a rise of 0.4% in the June quarter, which was the same as the rise in the preceding March quarter. For the 12 months to June the CPI rose 2.4%, which sits comfortably within the RBA’s 2% to 3% target range. Given it is towards the lower end of the range it provides scope for a further cut to invigorate growth.

Deloitte Access Economics in its latest commentary suggests there is little chance of a recession, with forecaster Chris Richardson saying there was little sign Australia’s overall growth will turn negative, however Richardson also admitted that if coal or iron ore prices drop further then a recession could eventuate.

The world economy is still a scary place

Last week the city of Detroit in the USA filed for bankruptcy. It’s the largest such filing ever in US history. The cause? Its industrial base has been shattered.

China’s growth continues to slow considerably. There are both external (lack of export demand) and internal (government spending, shadow banking, the list goes on) reasons for this slowing but as the Nobel Laureate in Economics, Michael Spence said recently “China’s end of exuberance” has arrived.

To further reinforce the outlook for China, HSBC’s latest finding show China’s Purchasing Managers Index (PMI) is at an 11-month low and continues to be in contraction mode having declined to 47.7.

Winners & losers

A slowing Chinese economy has deep ramifications for many Australian companies. The most directly exposed include BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). While a weakening exchange rate will certainly buffer the pain for the mining majors, potential lower demand and lower prices do not bode well.

Conversely, material supply companies such as Boral (ASX: BLD) and James Hardie (ASX: JHX) stand to gain from lower interest rates. With housing supply under pressure in Australia, companies exposed to the housing market are leveraged to gain from increasing demand for housing brought on by lower rates.

Foolish takeaway

For investors it’s somewhat of a catch 22. On the one hand, further rate cuts signify a slowing Australian economy, which is bad news for most businesses. On the other hand, lower interest rates have the potential to boost demand for certain goods and services which could help kick-start many company revenues which have flat lined.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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