Australian Central Bank Rate Cut Forecast: 100 Basis Points

December 1, 2008

A drop of 100 basis points to 4.25% is near the high end of expectations. There were earlier easings of 25 basis points on September 2nd, 100 bps on October 7th, and 75 bps on November 4th. 4.25% would match the previous cyclical low from December 2001 to May 2002. The debate at the November meeting presented a choice of easing by 50 bps or 75 bps, and I think policymakers this time will select between drops in the cash rate of 75 bps or 100 bps.

My reasons for expecting an aggressive move are several.

  1. Officials have wanted to stay ahead of the curve so long as global economic momentum continues to deteriorate, which it has in the past month. Markets had priced in reductions of 50 basis points before both the October and November meetings. This time the consensus looks for a drop of 75 bps.
  2. Australia has been embroiled in the global recession through three separate channels. Domestic incomes and thus consumer purchasing power have been eroded by falling commodity prices, which fell another 2.7% in November. Household wealth has decreased sharply in line with a 46% decline of Australian equities from last year’s peak. Thirdly, demand has slowed in key export markets like China.
  3. Australian growth is also being squeezed by the previously tight monetary policy. Housing approvals and finance fell by 7.2% and 2.7% in September. Auto sales showed a double-digit percentage drop in the year to October.
  4. Inflation is likely to subside more quickly than assumed. Officials have warned that a weaker exchange rate will delay the return to in-target inflation until 2011. But other economies have reported a steeper drop in inflation than expected, and one gauge of Australian inflation reported today showed an outsized on-year drop to 3.0% from 3.9% in October and 4.8% in June, suggesting official forecasts on the rate of drop in inflation are too conservative. Hourly wages went up by less in 3Q than in 2Q.
  5. While Australia’s labor market has been surprisingly solid with a jobless rate of 4.3% in October and employment growth of 2.1% y/y, other data look very weak. The PMI-manufacturing slumped to 32.7 in November from 40.4 in October and had an orders component of just 24.5, down 14.4 points from October. The sister PCI index for housing construction fell to 22.9 in October from 27.9 in September and 63.0 a year ago. Retail sales volume in New South Wales dropped 1.8% in 3Q08, the worst quarter in 15 years. Consumer credit dropped in the last reported month at the sharpest rate in 17 years. Skilled job vacancies are 38% below year-ago levels. Business conditions sagged ten points to -11 in October, worst since April 2001, and business sentiment dropped 21 points to -29, a record low for this data series. Third-quarter growth will be marginally above or possibly marginally below zero.
  6. Officials want to establish a neutral monetary stance as quickly as possible. Evidence of falling expected inflation commands officials to adjust nominal interest rates more sharply than they might have been planning a month ago.
  7. The Australian dollar has recovered 7.6% since hitting a low of $0.6075 on November 21st.  Although more than 30% below its mid-July, exchange rate weakness has not intensified lately and seems unlikely to impede a drop in inflation as much as officials have assumed.
  8. Most central bankers these days feel a responsibility to bias their easing toward the aggressive side, lest they be seen failing to make fair share-contribution to supporting the global economy. Neighboring New Zealand’s central bank probably will cut its cash rate over 100 basis points this week.
  9. The Reserve Bank of Australia doesn’t schedule an interest rate meeting in January, which is mid-summer down under. That would not automatically preclude officials from easing at a special extra meeting if they deem such necessary. But markets will not assume that. A rate cut on the low side of expectations at this juncture might appear magnified because of the lack of a planned meeting until early February.



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