Will interest rates be at 2% by early next year?

Economists are predicting that the Reserve Bank of Australia (RBA) will cut interest rates to as low as 2% within the next six months, despite fears that such a move could increase the risk of a property price bubble.

Westpac’s (ASX: WBC) chief economist Bill Evans – who has been one of the most successful interest rate predictors over the last few years – has put forward that the RBA will be forced to reduce the official cash rate by 25 basis points by as early as November, whilst another 25 basis point cut would follow in the first quarter of next year.

Tipping that the jobless rate still has further to climb from today’s 5.8% to around 6.5% by mid-2014, Evans also believes that the stalling of growth in the non-mining sectors is a concern. Whilst he expects that these two rate cuts could cause the Australian dollar to fall to around US84c by the end of next year, such a move by the RBA would provide a boost to the economy.

Furthermore, Evans also believes that the global outlook is yet another reason for concern. He said, “The US economy will face another year of underperformance, China will disappoint next year and Europe is likely to record a third consecutive year of recession. This will leave the Australian economy sluggish and force the RBA to act.”

However, the RBA has remained cautious about cutting interest rates any further from their current level at 2.5%. Although the RBA’s half-yearly Financial Stability Review stated that the major banks, including Westpac, ANZ (ASX: ANZ), NAB (ASX: NAB) and Commonwealth Bank (ASX: CBA), have maintained their lending standards so far, it also warned that they must continue to do so in order to avoid a housing price bubble.

Foolish takeaway

The low interest rate environment has allowed the banks to drastically increase their earnings and profitability; however, it is vital that they do not relax their lending standards just to increase revenue further.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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