ONE LAST CUT BEFORE STEVENS HANGS UP THE SCISSORS

One last cut before Stevens hangs up the scissors

Like a punter tipping you the winner of the Melbourne Cup as the horses gallop past the winning post, everyone is now forecasting the Reserve Bank of Australia to cut interest rates at its board meeting next Tuesday.

For some time, it has been obvious that the Reserve Bank needed to edge interest rates a little lower, just to make sure the increasingly encouraging signs of a pick up in economic activity can be nurtured amid a climate of very low inflation and solid productivity gains.

Next week's interest rate cut will probably be the final installment of monetary policy easing in the cycle as there are signs that the economy is not only bottoming at a growth pace around 2.5 per cent, but that a move to trend GDP growth higher is on the cards for 2014. With that will come a gentle lift in inflation, which the central bank will want to lean against by not moving monetary policy to an even easier stance.

The fact that the Australian dollar is on a clear trajectory lower is also a significant factor behind a rosier economic outlook. Export growth, which is already in a rapid growth phase, will be further enhanced by the boost to competitiveness with the AUD at 90 US cents and lower.

Exports are now likely to add as much as 1.5 percentage points to GDP growth in 2014 as a result of a surge in mining output and the broader effects of the lower currency. This will be the foundation for growth over the next year.

The global economic environment is increasingly positive with a solid recovery in the US continuing to take shape. While China is slowing, this is exactly as the policy makers were intending, which means that the economy is moving to a more balanced position. It seems very unlikely that growth will slow below 7 per cent in China, which is still extremely positive for the global economy.

Even in the eurozone, which is hamstrung by a litany of huge problems, there are clear signs of a recovery with confidence levels trending higher.

Domestically, there is evidence that household consumption spending has picked up, albeit at a moderate pace. The Reserve Bank has noted in the minutes of the July Board meeting that "the Bank's liaison contacts suggested that sales rose modestly in May and June". This view of a further expansion in household spending fits with the recent measures of consumer sentiment, which remain a little above the long run average.

The Reserve will also have a close eye on credit growth which for housing is starting to edge higher. In the year to June, housing credit growth rose 4.6 per cent which was a six month high. At the same time, personal credit growth appears to have stopped falling which fits with a scenario of a pick up in household spending and a general rise in consumer sentiment.

Housing construction is also trending higher. The central bank noted that "conditions in the housing sector continued to improve gradually" and that "forward-looking indicators for new construction continued to be favourable" which will no doubt be enhanced by extremely low interest rates in the months ahead. While building approvals dropped a sizable 6.9 per cent in June, the broad trend in new housing construction is higher.

Another factor that might stay the hand of the Reserve Bank after next week's cut is a clear upswing in house prices. The RPData house price series rose a solid 1.6 per cent in July which follows a 1.9 per cent increase in June. With housing affordability near its most favourable in decades, more strong gains in house prices are likely, a point the Reserve would feel uncomfortable about if the trend accelerates in the next six to 12 months.

One ongoing wildcard for growth is the momentum in government spending. At both the Commonwealth and State government level, there remains a strong bias to tighter fiscal policy. In terms of a contribution to GDP growth, fiscal policy will be neutral, at best, and could even act as a further drag on growth. This depends on the extent to which policy is further tightening in the upcoming fiscal statement from Treasurer Chris Bowen.

To be sure, the current positive signs for the domestic and global economy could yet turn lower. The fall away in mining investment and the weaker terms of trade are significant issues. But these are the factors feeding into the lower interest rate structure so far and are not much worse than expected. Indeed, the RBA may well have to cut the cash rate below 2.5 per cent if things disappoint, but it is increasingly unlikely that even lower rates will be needed as the economy positions for a solid pick-up over the latter part of 2013 and into 2014.