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Australia Holds Key Rate as Shock Potential From Europe Lingers: Economy

Australia’s central bank reiterated it has scope to cut interest rates as Europe remains a potential source of shocks “for some time yet,” sending the nation’s currency to the lowest level in 1 1/2 weeks.

Governor Glenn Stevens and his board left the overnight cash-rate target at 4.25 percent, the Reserve Bank of Australia said in a statement in Sydney today, using a phrase he employed last month by calling policy “appropriate for the moment.”

Stevens’s second pause after two reductions late last year reflects confidence U.S. companies will keep hiring and domestic employment will be supported by A$456 billion ($483 billion) of resource projects to meet Chinese demand. He maintained a view that inflation will stay within the central bank’s 2 percent to 3 percent target range, even as the consumer-price index may weaken in the next quarter or two.

The currency’s fall reflects “markets positioned for a little more hawkishness and a dropping of the easing bias and it hasn’t been delivered,” said Ben Jarman, a Sydney-based economist at JPMorgan Chase & Co. (JPM) “Given the risks that are out there, the RBA didn’t want to seem deaf to that.”

The local dollar fell 0.5 percent to $1.0615 at 4:16 p.m. in Sydney from $1.0671 yesterday. It bought $1.0647 before the decision. The three-year bond yield fell to 3.63 percent from 3.71 percent yesterday and the 10-year yield declined to 3.98 percent from 4.04 percent yesterday.

No ‘Deep Downturn’

Recent information indicates “the world economy will grow at a below-trend pace this year, but does not suggest that a deep downturn is occurring,” Stevens said. “Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy.”

The MSCI Asia Pacific Index (MXAP), which has gained for 11 straight weeks, fell for a second straight day, losing 1.2 percent at 2:16 p.m. in Tokyo. Australia’s S&P/ASX 200 Index of stocks, down in four of the past five weeks, dropped 1.4 percent to a two-week low.

The RBA’s decision to maintain the highest benchmark borrowing costs among major developed economies was forecast by all 25 economists surveyed by Bloomberg News.

The Australian dollar, the world’s fifth-most traded currency, has strengthened about 4 percent this year as investors bet the nation’s economy will accelerate. It touched a six-month high of $1.0856 on Feb. 29 after the European Central Bank awarded 529.5 billion euros ($699 billion) in a second round of three-year loans to banks.

‘Source of Shocks’

“The acute financial pressures on banks in Europe have been alleviated considerably by the actions of policy makers, though there is more to do to put European banks and sovereigns onto a sound footing for the longer term and Europe will remain a potential source of shocks for some time yet,” Stevens said today.

The European Union’s statistics office will say today gross domestic product in the 17-nation euro area probably fell 0.3 percent in the last quarter of 2011 from the previous three- month period, according to the median estimate of economists in a Bloomberg News survey. That would be the first drop since the second quarter of 2009 and in line with a Feb. 15 estimate.

China is Australia’s biggest trading partner, and the RBA has said it expects Chinese demand for commodities to spur the domestic economy.

Manufacturing in China expanded for a third straight month, a purchasing managers index released last week showed. Still, China yesterday pared the nation’s economic growth target to 7.5 percent from an 8 percent goal in place since 2005.

China Dependence

“Growth in China has moderated as was intended, but on most indicators remains quite robust overall,” Stevens said today.

In the U.S., recent reports have highlighted growth that’s broadening, with data yesterday showing service industries unexpectedly expanded last month at the fastest pace in a year. Initial claims for jobless benefits fell in late February to the lowest level since March 2008, a sign the labor market in the world’s biggest economy is healing.

“Several European countries will record very weak outcomes, but the U.S. economy is continuing a moderate expansion,” Stevens said today.

Australia has grown more dependent on resources as employment in manufacturing dropped by about 30 percent since 2007, while mining and government rose by more than 50 percent, HSBC Holdings Plc (HSBA) estimates.

Manufacturers’ Woes

Auto exports plunged to the lowest since 1998 last year, leading to job cuts at General Motors Co. (GM) and Toyota Motor Corp. (7203)’s local units. Sydney-based David Jones Ltd. (DJS), the nation’s second-largest department store chain, said Feb. 23 that sales in the three months ended Jan. 28 fell 3.1 percent as spending stalled and the strong currency made it cheaper for shoppers to buy from overseas websites.

“If rates are likely to move anywhere in coming months, the risk is clearly on the downside,” said Craig James, a senior economist at Commonwealth Bank of Australia, the nation’s biggest lender, in Sydney. “Manufacturing, services and construction sectors are contracting; the high Aussie dollar is still troubling businesses; inflation is well contained.”

Australia’s economic growth probably decelerated to 0.8 percent last quarter from 1 percent three months earlier, a survey of 25 economists showed before a government report tomorrow. That takes the nation’s average expansion in the last nine months of 2011 to 1.1 percent, the fastest pace since 2007.

Inflation Outlook

The RBA “expects inflation to be in the 2 percent to 3 percent range,” Stevens said. “Credit growth remains modest. Housing prices have shown some sign of stabilizing recently, after having declined for most of 2011, but generally the housing market remains soft.”

After a rate pause last month, the country’s four biggest lenders -- Commonwealth Bank of Australia, National Australia Bank Ltd. (NAB), Westpac Banking Corp. (WBC) and Australia & New Zealand Banking Group Ltd. (ANZ) -- raised mortgage rates, citing higher wholesale funding costs.

Treasurer Wayne Swan said the RBA’s decision today to keep rates unchanged reflected Australia’s economic strength and resilience at a time of continued global uncertainty.

“The RBA has shown it has policy flexibility to respond if the global situation further deteriorates,” Swan said in a statement. “It’s clear global turmoil is having an effect on our region, but China continues to grow solidly and has a proven capacity to support domestic growth.”

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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