As expected the Reserve Bank has cut interest rates for the first time in seven years, dropping its cash rate 0.25% to 7%. The rate cut comes into force from tomorrow. Rates were last cut in 2001.

The Governor Glenn Stevens said in a statement this afternoon that “weighing up the available domestic and international information, the Board judged that there was now scope for monetary policy to become less restrictive. The Board will continue to assess prospects for demand and inflation over the period ahead, and set monetary policy as needed to bring inflation back to the 2-3 per cent target over time.”

That’s a significant change from the concluding paragraph of the August meeting statement that sent the signal that a rate cut was on the cards, though not certain. On August 5, Glenn Stevens said:

Weighing up the available domestic and international information, the Board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.

The bank again made prominent mention of high inflation, tight monetary conditions caused by the credit crunch and the continuing volatility in credit markets.

Inflation is likely to remain relatively high in the short term, with the CPI affected by the high global oil prices in mid year and other increases in raw materials prices.

But looking further ahead, the outlook for demand suggests that inflation in both CPI and underlying terms is likely to decline over time, provided wages growth remains contained. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.

That compares to the same sentence in the August 5 statement:

Looking further ahead, inflation in both CPI and underlying terms is likely to decline over time, given the outlook for demand, provided wages growth remains moderate. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.

But the bank has not only given itself the linguistic freedom to continue cutting interest rates in saying that the board will “set monetary policy as needed to bring inflation back to the 2-3 per cent target over time”, but it has also given itself the freedom to lift interest rates if inflation is more persistent than thought and shows no sign of easing as expected.

The Australian Bureau of Statistics publishes the second quarter national accounts tomorrow morning which are expected to show growth of between zero and 0.4%, which would give an annual rate of less than 3%, a definite slowing on the 5% plus at the end of last year. 

And like it had its statement written and someone’s finger hovering over the send button, the ANZ Bank has announced it will drop its own rates in line with the RBA’s announcement. The National Australian Bank, which was the first to promise it would follow the rBA rate cut and match it, is expected to follow the ANZ, which was the second bank to make such a promise.

Both banks have been forced to suffer poor publicity through disclosures about poor lending practices and multi-billion dollar write-offs that will cut 2008 earnings. The key will be just how and when the more profitable Commonwealth and Westpac follow.

However, the banks are still running a tip up margin of 0.55% because of the impact of the credit crunch, although much of that increase has dissipated for our banks in the past month.

 Here is the full statement from the RBA. STATEMENT BY GLENN STEVENS, GOVERNOR
MONETARY POLICY

At its meeting today the Board decided to lower the cash rate by 25 basis points to 7.0 per cent, effective 3 September.

Inflation in Australia has been high over the past year in an environment of limited spare capacity and earlier strong growth in demand. In these circumstances, the Board has been seeking to restrain demand in order to reduce inflation over time.

As a result of increases in the cash rate last year and early this year, additional rises in market interest rates and tougher credit standards, financial conditions have been quite tight. Some further tightening has occurred over the past couple of months. Conditions in international financial markets remain difficult, with heightened concerns over credit persisting.

The evidence is that the tight financial conditions, in conjunction with other factors including higher fuel costs and lower asset values, have exerted the needed restraint on demand. Indicators of household spending have recorded subdued outcomes over recent months, and credit expansion to both households and businesses has slowed. Surveys suggest a softening in business activity and growth in production has slowed. Indicators of capacity utilisation, while still high, are declining and there have also been some signs of an easing in labour market conditions.

The rise in Australia’s terms of trade that has occurred is working in the opposite direction, adding substantially to national income and ability to spend. Fixed investment spending by businesses continues to be very strong. At the same time, high prices of oil and a range of other commodities have added to global inflationary risks. They are also dampening growth in a number of countries.

Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation. On balance, however, it is looking more likely that household demand will remain subdued and overall economic growth slow over the period ahead. Inflation is likely to remain relatively high in the short term, with the CPI affected by the high global oil prices in mid year and other increases in raw materials prices. But looking further ahead, the outlook for demand suggests that inflation in both CPI and underlying terms is likely to decline over time, provided wages growth remains contained. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.

Weighing up the available domestic and international information, the Board judged that there was now scope for monetary policy to become less restrictive. The Board will continue to assess prospects for demand and inflation over the period ahead, and set monetary policy as needed to bring inflation back to the 2-3 per cent target over time.