RBA Rate-Cut Bets Waver Amid 2011’s Steepest Bond Rout: Australia Credit

Bond investors are showing doubts the Reserve Bank of Australia will cut the developed world’s highest benchmark interest rate as progress on solving Europe’s debt crisis spurs the biggest debt-market sell-off this year.

Yields on Australian three-year notes rose 35 basis points between Oct. 7 and Oct. 28, the most in a three-week period since December, and exceeded 4 percent the first time since Aug. 4. They grew 19 basis points this month to 3.4 percentage points more than similar Treasuries, the first gain since April.

Wagers that RBA Governor Glenn Stevens will lower borrowing costs for the first time in 31 months gyrated last week as data showing the slowest underlying inflation in 14 years was offset by optimism global financial turmoil will subside after European leaders expanded a bailout fund to aid heavily indebted nations. Cash-rate futures show an 84 percent chance the RBA will cut its 4.75 percent benchmark tomorrow, down from a 100 percent probability on Oct. 26.

“The door’s open for an easing but they may not choose to take up the option this month,” said Adam Donaldson, the head of debt research at Commonwealth Bank of Australia, the nation’s biggest lender. If policy makers decide not to cut, “it would be far too early to say they’re not going to do that,” he said.

Commonwealth Bank is the only one of Australia’s four biggest lenders predicting Stevens will keep rates unchanged.

Westpac Banking Corp., National Australia Bank Ltd., and Australia & New Zealand Banking Group Ltd. all predict a cut to 4.5 percent tomorrow. They are among 16 of the 27 economists surveyed by Bloomberg News who forecast borrowing costs will be lowered. The others see no change.

‘Insurance Cut’

Last week’s consumer-price report showed annual underlying inflation in the three months ended Sept. 30 averaged about 2.5 percent, the mid-point of the central bank’s 2 percent to 3 percent target range.

“With third-quarter underlying inflation extremely low, the RBA now has a trigger for cutting rates from a ‘slightly restrictive’ 4.75 percent to a neutral 4.5 percent,” economists led by Sydney-based Kieran Davies at Royal Bank of Scotland Group Plc wrote in a note to clients. Concerns Europe’s economy may falter and likely downgrades to RBA’s growth forecasts may lead policy makers to make an “insurance rate cut” to bolster confidence, RBS said.

TD Report

A private report today showed consumer prices in Australia rose 2.6 percent this month from a year earlier, compared with a 2.8 percent annual gain in September. Prices increased 0.1 percent in October from a month earlier after a 0.1 percent advance in September, according to the index compiled by TD Securities Inc. and the Melbourne Institute released in Sydney.

In contrast, an RBA report today showed loans provided by Australian banks and finance companies increased by the most since March. The 0.5 percent gain in private credit in September from the previous month also exceeded economists’ estimates for a 0.3 percent increase.

Ten-year government yields are poised to rise for the first month in 2011, climbing 31 basis points since Sept. 30 to 4.53 percent on speculation that Australia’s economy will strengthen. Yields fell in each of the prior nine months, the longest stretch on record. The three-year Australian government yield rose nine basis points last week to 3.94 percent and touched 4.02 percent on Oct. 28, before declining to 3.89 percent today in Sydney.

The implied yield on the November cash-rate future jumped to 4.565 percent at the end of last week. It had dropped 8.5 basis points, or 0.085 percentage point, to 4.49 percent on Oct. 26 when the government said quarterly underlying inflation slowed to 0.3 percent, the weakest since the third quarter of 1997. That was the biggest one-day drop in more than a month.

No Urgency

Stevens’s deputy, Ric Battellino, signaled in an Oct. 25 speech that there’s no urgency to reduce rates as policy makers weigh weak growth abroad against a domestic mining boom, improvements in retail sales, housing loans and employment. He also reiterated the RBA’s view that it has scope to reduce borrowing costs if needed as a slower domestic expansion eases pressure on inflation.

Market interest rates have fallen and the nation’s currency has undergone a “modest” decline, leading to “reduced pressure on some sectors of the economy,” Battellino said. The RBA will release its medium-term economic growth and inflation forecasts on Nov. 4.

Australia’s dollar reached $1.1081 on July 27, the highest level since it was freely floated in 1983, and traded at $1.0578 as of 1:37 p.m. today in Sydney. It surged 9.3 percent since Sept. 30, heading for the steepest monthly climb since May 2009 and almost reversing its 9.8 percent tumble in September when global risks increased.

European Leaders

Concern that the global economy would slow eased last week as European leaders agreed to boost the firepower of the region’s rescue fund to 1 trillion euros ($1.4 trillion) and persuaded bondholders to take 50 percent losses on Greek debt, responding to pressure to come up with a credible plan before this week’s Group of 20 meeting in France.

Australia’s sovereign debt has lost 0.8 percent this month, including reinvested interest, bringing this year’s gain to 9.6 percent. The securities soared 9.6 percent in the 12 months ended Sept. 30, the most among 26 markets tracked by Bloomberg/EFFAS indexes.

The Markit iTraxx Australia index of credit-default swaps that gauges perceptions of corporate bond risk declined 26.75 basis points last week to 155.75 basis points, the biggest fall since July 2009, according to prices from CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The gauge dropped for a fourth week, the longest stretch since April.

China Demand

Demand for iron ore, coal and natural gas from China, the world’s second-biggest economy, is driving Australia’s expansion. Fortescue Metals Group Ltd., Australia’s third- biggest iron ore producer, raised $1.5 billion last week in the biggest junk-bond sale worldwide by a miner in five months.

The gap between yields on Australian government bonds and inflation-indexed notes shows investors estimate consumer prices will rise an average of 2.45 percent for the next five years, up from 2011’s low of 2.37 percent on Oct. 4.

Employment in Australia has weakened this year as the currency’s climb to a record hurt manufacturing and tourism, and consumers salted away cash rather than spend it.

The RBA’s “forecasts will still show underlying inflation rising from here, albeit now within the target band, reflecting the massive mining boom and weak productivity growth,” said Paul Bloxham, chief economist for HSBC Holdings Plc in Sydney and a former central bank official. “With policy likely to be set on this central forecast, we expect them to hold next week.”

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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