Australian Interest Rate Preview

November 30, 2009

Most analysts had comfortably assumed that the Reserve Bank of Australia (RBA) will announce a third 25-basis point rate hike at 01:30 GMT on Tuesday in follow-through to similar 25-bp increases on October 6 and November 3rd.  That remains the baseline consensus, but confidence in the forecast has diminished.

The case for a hike rests on several factors.

  • Rhetoric, including the central bank’s quarterly policy statement this past month, has been upbeat, even bullish about the economy.  Officials note that Australia escaped recession, which had not been their expectation a half year ago.  There is less slack in the economy than had been assumed, and projected future growth of 1.75% in FY08/09, 2.25% in FY09/10, and 3.25% in FY10/11 was revised upward.  The economy’s resilience and relatively sound financial institutions were stressed.  Chinese demand represents a significant stimulus.
  • The current cash rate of 3.5% after two increases remains historically low.
  • Fiscal policy has been very expansionary.
  • Inflation should trend up. Core will be above the 2.0% target floor at 2.25% late next year and 2.5% late in 2011.
  • The housing market is improving.  The latest reported rise of housing finance, 5.1%, was the best gain in a half year.  Construction completions rose 2.2% last quarter and 6.9% from 3Q08.
  • Other upbeat data have been released.  The labor market stabilized sooner than anticipated.  The jobless rate was 5.8% in four of the past five reported months, and jobs went up 24.8K in October instead of dropping around 10K, which was predicted.  The index of leading economic indicators is rising fairly briskly.  An index of business conditions advanced to 12 in October from 3 in September, and the service sector PSI index jumped 5.5 points in October to a robust reading of 54.8.  Auto sales rose 2.2% in the year to October, the first on-year advance in 16 months.
  • In January, which it’s summer in Australia, monetary policymakers do not plan to meet.  It’s the only month of the year that gets skipped.

The main catalyst for second-thoughts about the RBA’s decision was the surprising news that investment spending fell 3.9% last quarter after a 2.1% increase in 2Q, which was reported last week.  Minutes from the November meeting called the pace of future rate increases “an open question,” implicitly suggesting that pauses may be inserted in the road back to a neutral stance.  A further sign that manufacturing is being depressed by the overvalued Aussie dollar was a 0.3 point slip in that sectors PSI index last month.  Retail sales still look cautious, dipping 0.2% in September instead of gaining an expected 0.5%.  Private credit growth was flat in October, and job ads fell for the first time in three months.  The Aussie dollar, which is up 1.1% since the November RBA meeting, and by 45.5% since early March, can also be counted upon to constrain inflation.  One measure of projected inflation dropped in its latest reading.

Only two other major central banks have joined Australia’s in raising interest rates already.  The Bank of Israel has also done it twice, and the Norges Bank has lifted Norway’s benchmark just once.  Prior to the RBA’s hikes in October and November, the cash rate had been slashed from 7.25% to 3.0% in six moves: 25 basis points in September 2008, 100 bps in October, 75 bps in November, 100 bps each in December and February, and a final 25 bps last April 8.  The trough in the prior three easing cycles were 4.25% from 12/01 to 05/02, 4.75% from 12/98 to 11/99 and 4.75% from 07/93 to 08/94.  Those earlier cyclical lows remain 75-125 basis points above the present 3.5% cash rate level, suggesting that officials may consider it premature to insert a pause now in their glide path back to a normal rate setting.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.



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