RBA Faces Rate Pressure as CPI Outweighs Record Currency: Australia Credit

The Australian currency’s surge to a record won’t slow the economy and contain inflation as money market yields signal Reserve Bank Governor Glenn Stevens will resume raising interest rates.

Bank bill futures for December delivery dropped to the lowest in more than a month on the Sydney Futures Exchange, indicating a 68 percent chance the central bank will boost borrowing costs after a government report showed consumer prices rose 1.6 percent last quarter, the fastest pace since 2006. The bank bill futures fell for a second day today to 95.080 compared with 95.075 on March 11.

The nation’s currency, known as the Aussie, soared more than 18 percent against the U.S. dollar in the past year as Stevens lifted rates and a mining-investment boom drove unemployment below 5 percent. Short-term bond yields climbed and inflation expectations gained the most in more than a month as the data showed measures that strip out volatile prices such as food and energy exceeded economists’ forecasts.

The key issues for the RBA “will be the labor market and the exchange rate, which are both working in opposite directions,” said Paul Bloxham, chief economist at HSBC in Sydney and a former Reserve Bank official. “Balancing these two influences will be the task undertaken as the RBA revises its consumer-price index forecasts over the coming days.”

Photographer: Mark Graham/Bloomberg

Glenn Stevens, governor of the Reserve Bank of Australia. Close

Glenn Stevens, governor of the Reserve Bank of Australia.

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Photographer: Mark Graham/Bloomberg

Glenn Stevens, governor of the Reserve Bank of Australia.

The bank bill futures fell for a third-straight day to 95.080 today, giving an implied yield of 4.92 percent. The RBA’s benchmark rate of 4.75 percent compares with a range of zero to 0.25 percent in the U.S., a band of zero to 0.1 percent in Japan, and 1.25 percent in Europe.

Fed Rates

Traders have cut bets that the Federal Reserve will increase rates this year. The likelihood Fed policy makers will raise the target rate for overnight lending between banks by their December meeting declined to 18 percent, from 24 percent a week ago, Fed funds futures showed yesterday.

The local currency reached $1.0947 today, the highest since exchange-rate controls were scrapped in 1983. Its advance against the U.S. dollar in the past year is the third-largest among Group of 10 currencies.

Australia, the only economy in the G-10 currency group to avoid a recession following the 2008 financial crisis, has the highest inflation expectations among eight developed markets tracked by Bloomberg.

The gap between yields on five-year inflation-linked bonds and debt not indexed to consumer prices yesterday widened two basis points, or 0.02 percentage point, to 3.04 percent today, the highest since April 20. The gap represents the rate of inflation anticipated by investors as the central bank aims to keep inflation in a range of 2 percent to 3 percent on average.

‘Dampening Influence’

“It looks like the Australian dollar is exerting less of a dampening influence in early 2011 compared with most of last year,” said Su-Lin Ong, a fixed-income strategist at RBC Capital Markets in Sydney. “Stripping out the impact of the Queensland floods confirms a broadening in price pressures in the quarter and an acceleration in underlying price pressures.”

Prime Minister Julia Gillard said in an interview last month she’s worried about the stresses posed by the appreciation of the Australian dollar.

While gains in the currency aided the RBA’s task of controlling inflation in recent quarters by reducing import costs, it has hurt some manufacturers that sell goods abroad.

“I’m very conscious that a strong Australian dollar has benefits and it has burdens,” she said March 3 in Canberra. “It certainly has burdens for some of our industries like manufacturing and tourism.”

Aussie Forecast

Commonwealth Bank of Australia (CBA), the nation’s largest lender, raised its forecasts for the local dollar yesterday, on expectations the currency will retain its interest-rate advantage over the greenback.

The so-called Aussie will reach $1.12 by the end of September, before declining to $1.04 at year-end, Richard Grace, chief currency strategist for the Sydney-based bank, wrote in a note to clients. Commonwealth Bank previously forecast the currency would fall to 94 U.S. cents by Sept. 30.

Stevens boosted the benchmark lending rate by 175 basis points to 4.75 percent from October 2009 to November last year, from a half-century low of 3 percent, to control prices as Chinese demand for energy and minerals encouraged hiring. Australia’s benchmark rate compares with 1.25 percent in the euro zone and as little as zero in the U.S.

RBA on Hold

The RBA’s halt to rate increases at its past four meetings contrasts with central bankers from Beijing to Frankfurt who are trying to stamp out inflation with higher borrowing costs or by signaling monetary policy needs to be tightened.

Stephen Roberts, a senior economist at Nomura Australia Ltd. in Sydney, yesterday reiterated his “out-of-consensus” prediction that the RBA will raise rates next week as inflation pressures build. At least 25 other economists surveyed by Bloomberg forecast no rate change at the May 3 meeting.

The Reserve Bank said earlier this month that it will “look through” the increase in inflation and slowdown in growth triggered by rains and storms in Queensland in January and February. The disasters compounded concerns about labor shortages as an area the size of Egypt was declared a disaster zone, including parts of the state capital, Brisbane.

Queensland produces 80 percent of steelmaking coal exports from Australia, the world’s biggest supplier, and grows more than 30 percent of the nation’s fruit and vegetables.

Queensland Impact

Finding skilled labor for reconstruction in Queensland, plus the flood-damaged eastern states of Victoria and New South Wales, may become more difficult. A mining industry’s expansion has caused a worker shortage at a time when the jobless rate is at the lowest level in two years.

Two coal-seam gas projects, expected to cost more than A$30 billion ($32.5 billion), are proceeding near the Queensland port of Gladstone. Santos Ltd. (STO), Australia’s third-largest oil producer, and BG Group Plc, the U.K.’s third-biggest gas producer, will start hiring the first of more than 10,000 construction workers needed for the two projects later this year.

Australia’s economic growth accelerated in the final three months of last year, the eighth-straight quarterly expansion, before the floods and cyclones ravaged the nation’s northeast.

Longer-term debt has climbed relative to shorter maturity notes, flattening the so-called yield curve, amid prospects that the RBA will take action to damp price increases. Longer maturities are more sensitive to expected changes in inflation, which diminishes the value of the fixed payments from debt.

Falling Yields

The 10-year government bond yield declined 1 basis point to 5.44 percent. The difference between 3- and 10-year yields shrank five basis points to 35 yesterday, extending a decline from this year’s high of 53 on March 15. The gap was last at 36.5 today.

The two-year yield rose four basis points to 4.98 percent yesterday, Bloomberg data show, and was at 4.96 percent at 3:47 p.m. today in Sydney. The premium over similar-dated U.S. Treasuries was at 434 basis points, climbing from an eight-month low of 407 on April 5.

Yesterday’s stronger-than-expected report on consumer prices “will provide a wakeup call to a complacent market,” RBC’s Ong said.

To contact the reporters on this story: Michael Heath in Sydney at mheath1@bloomberg.net; Garfield Reynolds in Sydney at greynolds1@bloomberg.net

To contact the editors responsible for this story: Rocky Swift at rswift5@bloomberg.net; Iain Wilson at iwilson2@bloomberg.net

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