RBA to cut rates by 25 basis points next week and reduce cash rate to 2.75% by year-end: Westpac

Westpac expects the Reserve Bank to cut the cash rate by 25 basis points next week (June 5) to 3.5% with further rate cuts in July, August and one in the fourth quarter to bring the cash rate to a record low of 2.75%.

Westpac had previously expected the current easing cycle, which began in November last year, to end at 3.25% but now expects a much deeper cycle of rate cuts due to the deteriorating global picture.

Taking into consideration the gap betweeen the cash rate and bank mortgage rates, Westpac chief economist Bill Evans says a move to 2.75% in the official cash rate is likely to see the cash rate somewhere between 100bps and 145bps below neutral (curently asssessed as 4.1% by Westpac) - meaning an average standard variable mortgage rate of between 6.05% and 6.5%.

"In the three previous easing cycles the official cash rate has bottomed out at 150bps (2008/09); 125bps (2001) and 50bps (1996/97) below neutral.In those periods the standard variable mortgage rate bottomed out at 5.8% (2009); 6.05%(2001); and 6.7% (1997).

"The contrast with 2009 is important. Despite the cash rate falling below its GFC trough, we expect the standard variable mortgage rate will bottom out well above the 2009 level," he says.

The cash rate reached a previous low of 3% in April 2009 according to RBA records going back to 1990.

Evans says the two extra rate cuts are based on the banks assessment that “the global environment – read Europe - has deteriorated even further since we revised down our call for the low point from 3.75% to 3.25%.

“In turn this deterioration is expected to have a more severe impact on confidence in Australia than had earlier been expected.

“The stance of policy is currently only mildly expansionary despite the official cash rate being at 3.75%, its lowest level outside the GFC,” says Evans.

Evans says Westpac does not favour a 50 basis point cut scenario in June.

“The decision to cut by 50 basis points in May was mainly driven by direct concerns around the domestic economy.

“To us, there appeared to be an element of catch up with the Bank holding steady in February-April when the domestic case for a cut was strong.

“The decision next week will be built around the impact that the deterioration in global confidence will have on the Australian economy.

“Since the Board meeting in May US 10 year bond rates are down from 1.9% to 1.6% and the Australian equivalent is down from 3.6% to 2.9%.

“However, there are a number of key risk events over the next few weeks (Greek elections on June 17 for example) which will be critical for global confidence.

“We expect a more orderly approach to addressing these issues and thus a more ‘considered’ 25 basis points move.

 “However nobody can be particularly confident in gauging the Bank's meeting-by-meeting strategy for dealing with these issues,” says Evans.