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Interest rates tipped to hit record low as economy sputters

Sean Aylmer and John Garnaut
June 1, 2012 Read later
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WESTPAC’S most senior economist expects the official interest rate set by the Reserve Bank will fall to its lowest level on record by the end of the year, as global woes and falling consumer confidence stall the local economy.

Westpac chief economist Bill Evans, who last year correctly forecast that the central bank would slash rates this year, said the official rate would drop as low as 2.75 per cent by Christmas and standard variable rates on mortgages would fall to about 6 per cent.

His comments came as new figures show that while investment in the mining sector remains strong, in other areas spending has largely stalled. And the outlook for the miners is not as robust as had been hoped.

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China’s steel mills, which dominate the market for Australia’s most lucrative export, iron ore, say they are fighting for survival, even as Beijing steps in to lift a sagging Chinese economy.

Local financial markets are fearful that the mining boom will falter. During May the local sharemarket had its worst month in a year. The share prices of BHP Billiton, Rio Tinto and Fortescue all fell by more than 10 per cent and the ASX/S&P 200 Index ended 7.3 per cent lower for the month. The dollar was worth US97.41ยข last night and is now trading around six-month lows.

”You can’t ignore what’s going on in the market. There’s a fair degree of disquiet,” Mr Evans said. ”Monetary policy is too tight given the shock to confidence and the fragility of the economy. Retail has lost its momentum, house prices have edged off, capital spending is quite soft, excluding mining.”

Rather than a big-bang approach, such as the RBA took in May when it cut the official rate by 0.50 percentage points, Mr Evans expects 0.25-percentage-point reductions in June, July and August and one more by the end of the year.

In 2009, after the global financial crisis, the official rate fell to 3 per cent, and the average mortgage rate dropped to about 5.8 per cent. The average mortgage rate is now just over 7 per cent and Mr Evans thinks the RBA will have to cut sharply to push down home loan rates and stimulate the economy.

The mining sector has underpinned economic growth in recent years, although recent comments by some companies suggest they will cut back on spending. Critical to their plans is the outlook for China, particularly its steel mills.

Last month alone, China’s steel mills bought 25 million tonnes of Australian iron ore, which was 12 per cent less than March but still 22 per cent higher than one year earlier.

”Steel mills are under great pressure,” said Hu Kai, a Shanghai analyst with Umetal.com. ”Trading conditions are very, very bad right now.”

China’s steel mills collectively lost 1 billion yuan in the first three months of this year, according to the main industry association, and many are bringing forward maintenance on huge blast furnaces in order to trim production.

”There will be limited demand from new stimulus

projects like water conservation, airports and roads,” said Yin Jinmei, general manager of the Tangshan research group Steelbus, after listing 13 steel mill blast furnaces that had been idled in Tangshan alone.

Beijing’s recent round of investment approvals include three huge state-owned steel mills which, together, will produce about 10 times Australia’s current steel production. While the approvals will boost short-term construction activity, they will also accelerate an official program to close small mills in order to reduce industry-wide overcapacity.

”The recent closures of ‘backward capacity’ have actually shut down private and small mills, when the fact is that small mills were more profitable than large ones,” said Hu Kai. ”If it is left to the market to decide, then it will wash out the state-owned firms first.”

Central planning officials have fast-tracked approvals for a slew of new investment projects including airports, railways and dams, after their efforts to encourage banks to lend more money proved ineffective. But they have been at pains to avoid suggesting they will launch another stimulus plan to kick-start economic growth. With

Read more: http://www.smh.com.au/business/interest-rates-tipped-to-hit-record-low-as-economy-sputters-20120531-1zkt0.html#ixzz1wW4ugkHx