Australia Woes Boost Rate-Cut Bets
Australia’s Central Bank Keeps Interest Rates on Hold in Attempt to Cushion Economy From China’s Slowdown and End of Mining Boom
SYDNEY—Tumbling commodity prices and signs of slowdown in China have reversed bets on the chances of an Australian rate cut next year.
As recently as two weeks ago, financial markets were pricing in a negligible chance of interest rates—currently at a record low to help spur a weak economy—moving up or down for at least the next year.
But after weak Chinese manufacturing data, Japan diving into recession, and a continuing decline in the price of Australia’s biggest export, iron ore, markets are factoring in a 71% chance of a rate cut in late 2015 and a 50% likelihood of one even earlier, analysis of the interest rate swap market showed.
At the start of the year, the consensus expectation was for a rate rise sometime next year.
Australia’s central bank left its policy rate at 2.5% on Tuesday, as expected, to help cushion the economy against the end of a mining-investment boom, while indicating it intends to keep it low for some time yet. The last time the Reserve Bank of Australia cut rates was in August 2013, at the end of a long string of gradual reductions dating back to late 2011.
Until now, economists had virtually ruled out the chance of rates dipping any lower before rising again. The current mood in markets comes after a plunge in the price of iron ore, which has tumbled by around 50% since the start of the year to its lowest level since June 2009.
Other commodities have also weakened, including coal, copper and gold, denying resource-rich Australia the stellar export-price boom anticipated after a decade spent investing in mine, port and rail infrastructure.
The current market pricing also reflects a major turnaround from earlier this year when economists were making confident forecasts Australia would recover relatively quickly from the end of the mining boom.
On Tuesday, Deutsche Bank dramatically changed its interest-rate forecasts, saying the fall in commodity prices meant it no longer expected a rate increase in 2016, and that it now saw two quarter-point rate cuts by the end of next year amid rising unemployment—which would drag the cash rate down to a new record-low of 2.0%.
Adam Boyton, chief economist of the Australian arm of the investment bank, said the central bank would be more open to cutting interest rates now that new regulation restricting lending to property investors was in the offing, lessening the risk of a housing-market crash that could upturn the economy.
Deutsche Bank joins Morgan Stanley and Credit Suisse in recently turning significantly more bearish on Australia. Trouble in Australia’s key trading partners, including Japan, has further fed rising doubts about the country’s economic prospects. Growth in China’s manufacturing sector slowed in November, adding to concern that its economy will cool in 2015.
Kieran Davies, chief economist at Barclays , Australia, is among those holding to the belief that the next move in Australian interest rates will be up. However, he said the central bank could afford to keep rates at the current level for longer than he’d originally thought. Mr. Davies pushed back his forecast for a rate increase to the third quarter from the first quarter of next year.
A sharp drop in the Australian dollar, or Aussie as it is known, in recent months against the U.S. currency has given Australia’s commodity exporters some relief from the steep price declines. But on Tuesday, the reserve bank said it wasn’t satisfied the Aussie, which has barely moved against a basket of major currencies, had fallen enough.
“The Australian dollar remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices in recent months,” Gov. Glenn Stevens said in a statement accompanying Tuesday’s decision to hold rates. “A lower exchange rate is likely to be needed to achieve balanced growth.”
Some economists said the comments reflected frustration the currency wasn’t falling fast enough to match sinking commodity prices. The Aussie dollar hit a fresh four-year low US$0.8420 on Monday.
The drop in commodity prices has also thrown the government’s budget off course, forcing revenue write-downs that will impair its ability to deliver a surplus before the end of the decade. Australia is expected to announce reasonably solid growth for the third quarter on Wednesday, but economic activity outside of mining looks set to remain sluggish.
