Expecting a 50-Basis Points Australian Rate Cut Tonight

November 3, 2008

First Some History: From a cyclical low of 4.25% in early 2002, the Reserve Bank of Australia lifted its cash rate in numerous steps to a peak of 7.25%. The final increases were administered in February and March of this year. A tightening bias was removed by the central bank at midyear and replaced by an easing bias at the August monthly meeting. The first rate cut, a modest drop of 25 basis points, was announced on September 2nd. On October 7th, a follow-up 100-basis point reduction to 6.0% was justified by a need to combat sharply higher bank funding costs even for credit-worthy borrowers and a deteriorating world growth prognosis. The statement in October acknowledged that policymakers had approved “an unusually large movement in the cash rate…to bring about a significant reduction in costs to borrowers” but said the size of the move is not meant to serve as a prototype for future actions. The statement, moreover, asserted that CPI inflation would crest higher in 3Q at around 5.0% and that the goal of returning such to 2-3% remains a high priority. A month ago, Street expectations initially felt that rates would only drop 25 basis points in November.

Bad to Worse: October was a horrific month for Australia like everywhere else. The local stock market fell 14.4% on top of a 28% slide over the first three quarters of 2008. Consumer price inflation did accelerate to 5.0% and 4.7% on the core index, and producer price inflation catapulted far more than anticipated to 5.6%. But there were many indications of slumping output and demand: consumer confidence dove to 82.0 in October from 92.2 in September, the manufacturing PMI dropped to 40.4 from 47.2, retail sales declined 1.1% in September, job ads slumped 5.9%, motor vehicle sales fell 8.2% y/y, jobs firmed just 2.2K, the jobless rate increased two-tenths to 4.3%, housing finance fell 2.2%, new home sales decreased 1.8%, and business sentiment and conditions both had sub-zero readings. Commodity prices tanked, heralding a dramatic reversal of the terms of trade in the future, which will hit incomes in this commodity-dependent economy. Consensus expectations of the size of Australia’s rate reduction, which will be announced at 03:30 GMT Tuesday (22:30 EST tonight), now center on 50 basis points, which under the circumstances seems reasonable. The cash rate would still be 5.5%, 450 basis points above the Federal funds level and 225 bps greater than the expected ECB refinancing rate after this Thursday. Australia’s central bank releases a new quarterly monetary policy statement on November 10th and minutes from today’s policy meeting on November 18th.



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