Stevens Cornered as Aussie Risk May Drive Rates Lower
Glenn Stevens was confounded for 1 1/2 years as the Australian dollar’s strength defied his interest rate cuts, prompting him to reduce borrowing costs to a record low. The threat of a rebound means he can’t relax yet.
The Aussie dollar stabilized between 90 U.S. cents and 93 cents for the past month after a two-month, 10 percent tumble, as traders awaited Stevens’s next move. Swaps contracts show a 76 percent chance he’ll lower the benchmark rate by a quarter percentage point to 2.5 percent on Aug. 6.
“There is a risk that if the RBA doesn’t cut interest rates again, or stresses the fact that the Aussie dollar has come down so there is upward pressure on inflation, that it might actually cause the Aussie to start going up again,” said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors Ltd.
With the Reserve Bank of Australia’s preferred inflation gauge below the midpoint of its 2 percent to 3 percent target for six straight quarters, the Australian dollar is taking over as the key determinant of rates policy. A change in emphasis from Stevens on the currency reflects its growing importance.
The Aussie “has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates during that time,” Stevens said in a statement accompanying the most recent interest rate cut on May 7, when the currency was trading at around $1.02. In minutes of that meeting released May 21, he said the higher currency may be weighing on business conditions.
In statements explaining the RBA’s decisions in June and July to keep rates unchanged, Stevens reiterated the inflation outlook “may provide some scope for further easing.” The minutes of the July 2 meeting, released two weeks later, deviated from that, acknowledging that the Aussie’s decline was raising the outlook for prices, which “could still provide some scope for further easing.”
“They’ve really only changed one word but it does suggest that they’re not quite so certain about the inflation outlook as they were a few months ago,” said Michael Blythe, chief economist in Sydney at Commonwealth Bank of Australia (CBA), the nation’s largest lender.
While the local dollar dropped after the May rate cut, Stevens began to see genuine currency relief when U.S. Federal Reserve Chairman Ben S. Bernanke signaled for the first time on May 22 that a tapering of bond purchases may be on the cards as the world’s largest economy strengthens. The Aussie fell about 6 percent since to 91.49 cents in Sydney at 10:29 a.m.
Illustrating the foreign-exchange market’s recent sensitivity to the RBA’s commentary, the local dollar posted its biggest back-to-back gains since November 2011 after this month’s minutes were released July 16. Thirteen days earlier, Stevens saw the bearish side of sentiment, when an unscripted remark that the board “deliberated for a very long time” at the meeting sent the Australian dollar to a 2 1/2-year low.
Under Stevens’s tenure as governor since September 2006, the Aussie has experienced its widest fluctuations since it started trading freely in 1983, swinging from 60.09 cents in October 2008 to a record $1.1081 in July 2011. With credit growth unresponsive to his latest series of rate cuts, the currency’s failure to adjust was further stymieing efforts to rebalance the economy as a mining-investment boom peaks.
Australia’s terms of trade, or export prices relative to import prices, climbed to a record in September 2011 before dropping 15 percent till March 31. The local dollar didn’t track the decline, forcing the RBA to begin an easing cycle in November 2011 to offset the currency’s strength. The RBA cut rates 2 percentage points since then.
“The currency has been a key swing factor for the RBA,” said Martin Whetton, an interest-rate strategist at Nomura Holdings Inc. in Sydney, who predicts a reduction in borrowing costs in August as inflation remains contained. “It drove the cut in May and allowed the pause in June and July. The stagnant domestic economy and weakening external environment will also weigh heavily going forward.”
Australia’s trimmed mean gauge of core inflation rose 2.2 percent from a year earlier, the Bureau of Statistics said in Sydney yesterday, the sixth straight reading of 2.3 percent or below. In its Statement on Monetary Policy in May, the RBA’s inflation and growth forecasts assumed the Aussie dollar trading at $1.02. The next statement is due Aug. 9.
“The exchange rate has now depreciated quite substantially so consistency would suggest that the RBA should be saying, given the fall in the currency there’s no longer the need to offset that through still lower interest rates,” said Ray Attrill, the Sydney-based global co-head of currency strategy at National Australia Bank Ltd. “The RBA is not saying that. It’s being a little bit clever and doesn’t want to signal that the exchange rate weakness is now doing some of the job of lower interest rates.”
In New Zealand, central bank Governor Graeme Wheeler said the pace of future rate increases will depend on the booming housing market’s impact on prices and reiterated he will keep borrowing costs at a record low 2.5 percent this year.
The kiwi gained 0.5 percent and the yen held declines. The MSCI Asia Pacific Index of regional equities fell 0.6 percent, extending its drop from an almost two-month high.
South Korea’s economy grew the most in nine quarters, central bank data showed, on stronger government spending and private consumption.
In the U.K., economic growth probably accelerated in the three months through June as Britain posted its first consecutive quarters of expansion in almost two years, economists predicted. In Germany, business confidence probably rose for a third month in July, indicating that Europe’s largest economy is recovering.
U.S. jobless claims likely rose by 6,000 to 340,000 in the week ending July 20, economists predicted before figures set to be released by the Labor Department in Washington.
Bill Evans, chief economist at Westpac Banking Corp. (WBC), said today the Federal Reserve is likely to have to continue with its stimulus program and “the big fall we saw in the Aussie dollar will start to unravel over the course of the rest of this year.”
He said Australia’s economy hasn’t responded to the RBA’s cuts as it did in the past, and predicts the government will lower its growth forecast to 2.5 percent.
“That’s why the case for more interest-rate cuts is very, very strong for Aug. 6,” Evans said at a breakfast forum in Melbourne today. “Inflation is not a constraint.”