Australian dollar slumps as much as 1.5% following decision
Stevens says price data suggests `lower outlook for inflation’
Australia’s central bank cut its benchmark interest rate to a record low and left the door open for further easing to counter a wave of disinflation that’s swept over the developed world. The move sent the local currency tumbling and stocks climbing.
Reserve Bank of Australia Governor Glenn Stevens and his board lowered the cash rate by 25 basis points to 1.75 percent Tuesday, a move predicted by just 12 of 27 economists surveyed by Bloomberg. The rest had seen no change. Data last week showed quarterly deflation in the consumer price index and the weakest annual pace on record for core inflation — which the RBA aims to keep between 2 percent and 3 percent on average.
“Inflation has been quite low for some time and recent data were unexpectedly low,” Stevens said in a statement. “These results, together with ongoing very subdued growth in labor costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.”
Australia’s central bank acted after two regional neighbors stood pat last week — New Zealand and Japan. Illustrating the impact of central bank decisions on exchange rates, the Aussie has the weakest performance among the G-10 since last Wednesday, a day before the Bank of Japan and Reserve Bank of New Zealand meetings. The yen hit an 18-month high minutes after the RBA’s release.
Australia’s rate reduction came just hours before its government hands down its budget, setting the scene for Prime Minister Malcolm Turnbull to call a general election. While Stevens didn’t rule out further monetary stimulus, he may choose to stay on the sidelines until after the election forecast to be held on July 2, or longer. Interbank cash rates futures for August were yielding 1.60 percent, indicating about a 60 percent chance that the central bank will cut rates by that month.
“Rate cuts will be off the agenda during the election period,” said Paul Bloxham, chief Australia economist at HSBC Holdings Plc in Sydney who previously worked at the central bank. However, “we expect that this won’t be enough and that the RBA will have to cut again because the downside risk to growth and inflation is significant,” he said.
The Australian dollar slumped after the rate decision, trading at 75.72 U.S. cents as of 4:08 p.m. in Sydney from as high as 77.19 cents earlier in the day.
The currency had risen as much as 15 percent after mid-January, gains likely to further restrain import prices in Australia. The exchange rate move also cast a cloud over the sustainability of both the Australian labor market’s improvement and the burgeoning tourism and education industries.
Still, Stevens wasn’t pessimistic on the economy, after it expanded 3 percent last year. “Indications are that growth is continuing in 2016, though probably at a more moderate pace,” he said, adding that labor market indicators have been more mixed of late.
“The domestic economy does not need additional support,” said Michael Blythe, chief economist at Commonwealth Bank of Australia. “GDP growth rates remain comfortably positive despite the headwinds from falling commodity prices and the end of the mining construction boom.”
The RBA reiterated that “an appreciating exchange rate could complicate” the economy’s transition away from mining investment. It also noted the rebound in iron-ore prices in response to policy easing in China, Australia’s biggest trading partner.
“Commodity prices have firmed noticeably from recent lows, but this follows very substantial declines over the past couple of years,” Stevens said. “Australia’s terms of trade remain much lower than they had been in recent years.”
He noted that China’s growth rate “moderated further” in the first part of the year.
The RBA has also been monitoring the impact of tighter regulations on residential home loans as house prices in Sydney and Melbourne surged in response to easier policy.
Three of Australia’s largest lenders — National Australia bank Ltd., Westpac Banking Corp. and CBA — cut their benchmark variable home loan rates by 25 basis points Tuesday, passing on in full the central bank’s reduction to their mortgage customers.
“In reaching today’s decision, the board took careful note of developments in the housing market, where indications are that the effects of supervisory measures are strengthening lending standards and that price pressures have tended to abate,” Stevens said. “At present, the potential risks of lower interest rates in this area are less than they were a year ago.”
Global policy is diverging and creating cross-currents as Europe and Japan move to negative rates and the U.S. tightens policy. That, together with a resurgent price for Australia’s biggest export, iron ore, has helped lift the Aussie dollar.
“If the RBA hadn’t delivered a cut then the Aussie dollar may well have tracked higher,” said Bloxham at HSBC. “And a higher Aussie dollar when inflation is already too low would’ve been a problem.”