Why interest rates are going down

YOU beauty. Interest rates have been cut and happy days are here again. For good measure, we've even got petrol prices coming down.Sorry, don't be too sure about that. The Reserve Bank has cut its official interest rate only because times are getting tougher. That's the way interest rates work: they go up when times are good and come down when times are bad.
To put it another way, a welter of indicators - for retail sales, the home-building industry, business and consumer confidence, levels of debt owed by households and businesses, and job advertisements - suggest the economy has entered a steep dive. Now the Reserve is cutting interest rates in an attempt to pull it out of its dive. Let's hope it succeeds and we suffer nothing worse than a brief and reasonably painless slowdown.
I have to tell you, however, that its record of success at this point in the business cycle isn't reassuring. Of course, those home buyers confident of holding on to their jobs during what economists euphemistically refer to as a "hard landing" have little to fear. For them the pressure is off.And the likelihood of recession in America, Europe and Japan suggests that weaker demand for oil in the developed world will see petrol prices continuing to fall for some time. interest rate movements are like cockroaches - there's always more than one. It's likely that this cut in the official interest rate will be followed by at least another one, probably as soon as next month. How many we get after that, however, depends on whether the economy continues its rapid slowdown next year.On this the Reserve Bank was at pains to point to the parts of the economy that are still strong: the further leap in the prices we are receiving for our exports of coal and iron ore, and the continued growth in business investment in equipment and construction.Provided the economy is holding up overall, the Reserve will be reluctant to cut rates a lot further. That is because the inflation rate is still well above the desired 2-3 per cent range.But if domestic activity continues its dive, the Reserve will soon stop worrying about inflation, confident that rapidly rising prices and weak demand can't coexist. In this case it will continue cutting interest rates next year, but this would be a sign our luck had finally run out. SMH 2/9/08