Credit Squeeze to Prevent Rate Rise, Analysts Predict

On the back of reports that fears of a US recession - due to the current credit squeeze - will conflict with booming domestic demand, comes news that demand for funding in the financial markets by major financial institutions is so great that the Reserve Bank may delay any prospective increase in rates in November.

In fact, traders are now suggesting that there is a ten percent chance of rates being cut at the next meeting of the Reserve, to match the 40 percent chance of an increase. 90 day bills were trading at an interest rate of 7.07 percent last week, compared to the current official cash rate of 6.5 percent.

"The widening gap between the bank-bill rate and the cash rate has been caused by specific demands for longer liquidity," said Citibank's fixed income analyst Philip Brown. "Cash remains available in the overnight markets in all the currencies that we cover." As a means of calming turbulent markets in Australia, the Reserve Bank has been actively trading, re-purchasing around $1.3 billion worth of bonds and bills. The increase in the rates on 90-day bills means that players in the financial markets are trading at an interest rate 0.57 percentage points above the current cash rate, which is costing the Reserve significant amounts of available liquidity.

As a result, there is a growing belief that this 'false' increase in interest rates will discourage the Reserve Bank from raising rates until early 2008 at the soonest, despite some analysts suggesting that rates may be cut.

This is considered unlikely by the wider financial community, however, given the recent rate rise and robust Australian GDP growth. The bulk of major analysts believe the Australian economy is currently strong enough to survive anything but a major collapse of the US economy. "The situation in Australia is quite different. It's almost polar opposites to the US," St George's head of economic research, Steven Milch said. "The housing market still looks more positive. There's no reason to cut rates. I don't think the RBA would possibly need to cut."

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Published on September 9-th, 2007 in Home Loans
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.
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