Hello,

Everyone seems to have an opinion about interest rates so I thought it timely to throw my 20 cents into the mix.

Interest rates represent the cost of money. The quickest way to reduce the demand for any commodity is to increase its price. Conversely, the opposite is true. Interest rates are usually increased to reduce economic activity (i.e. demand) and ease inflation pressures.

However, if demand is already weak as evidenced by slow retail figures, low non-mining GDP growth and higher unemployment, increasing interest rates further is not likely to impact inflation. Inflation has been rising on account of other factors, some unrelated to domestic demand.

The reality is that interest rates are already quite high and the longer they stay at this level the more likely a damaging round of contraction will occur in the non-mining sectors of the domestic economy.

I feel that October and November will herald a period of interest rate cuts. Easing cycles tend to be "short and sharp" and are often less than 1 year in duration. I feel that a 1% drop over the next 12 months is highly possible with a total of 0.5% drop prior to Christmas likely.

Another indication of the likely direction of interest rate movements is provided by the current available fixed rates. Three year fixed rates are currently being offered at about 0.5 - 0.6% below "package variable rates." This seems to suggest that money markets are too of the view that variable rates will soon decrease.

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Til next time,
Michael