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The Reserve Bank of Australia cut interest rates by 0.25% following its December Board meeting, taking the cash rate to 4.25%, this comes off the back of a similar cut on Melbourne Cup day.

What does this mean for us?

• Lower interest rates are mainly a function of the mounting global risks, rather than economic weakness at home.
• Europe remains the key concern for the RBA Board since for now, it remains a work in progress.  European leaders are holding another summit on Friday 9 December to continue hammering out a solution to the region’s sovereign credit and banking problems. 
• Slowing economic activity in Europe is beginning to have some impact on Asian trade.  The uncertainty in financial markets has raised the cost and reduced the availability of wholesale funding. 
• The RBA noted that growth was around trend and demand in the economy was even stronger.  Private demand in particularly is surging, as the long-awaited mining boom is lifting business investment.  But conditions outside of the mining sector remain challenging.  The softer jobs market means that wage pressures and inflation are less concerning. 

It remains to be seen whether the policy easing is fully passed on to end borrowings.  The funding environment for banks has been affected by the current heightened concerns about Europe. 

There is no fixed link between the RBA cash rate and borrowing rates.  If the RBA is unhappy with the degree of pass through they may move the policy rate further to get end borrowing rates to where they think are needed. 

Are we likely to experience further cuts?

We think further easing in rates is likely to be necessary, given the risks posed by the unfolding situation in Europe.  We currently are pencilling in another 0.25% cut in February 2012.

James McIntyre, Senior Economist, Commonwealth Bank  www.research.commbank.com.au  http://www.commbank.com.au/futurebusinessindex