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Traders Diverging From Stevens on Rate Rise: Australia Credit

Reserve Bank of Australia Governor Glenn Stevens
Glenn Stevens, governor of the Reserve Bank of Australia. Photographer: Patrick Hamilton/Bloomberg

Reserve Bank of Australia Governor Glenn Stevens has put the financial markets on notice that he’s likely to raise interest rates. Not this year, according to the bond markets.

Stevens will leave the cash-rate target at 4.75 percent tomorrow, matching his longest pause since taking charge in 2006, and is likely to keep borrowing costs unchanged for a year, money-market futures show. While economists also expect the RBA to hold interest rates this month, they forecast the benchmark will reach 5.25 percent by year-end, according to the median estimate of 28 analysts surveyed by Bloomberg News.

Stevens said June 15 rates probably have to climb “at some point” as “the underlying rate of inflation is more likely to rise than fall.” Bond investors are betting there’s no need to add to the developed world’s highest borrowing costs as Greece’s debt crisis roils financial markets and China’s growth slows. An inflation-expectations gauge shows consumer prices will rise at a rate below the top of the RBA’s target range.

“Traders do not believe that the RBA’s confidence in the China commodity story will play out as strongly as the bank assumes it will,” said Sean Keane, an Auckland-based analyst at Triple T Consulting, and former head of Asia-Pacific rates trading at Credit Suisse Group AG. “The trading market still believes the RBA is overestimating the strength of the Australian economy, and that rate hikes will not be necessary.”

Retail, Building Weaken

Australia’s currency and government bond yields fell today as government reports showed retail sales and building approvals dropped in May. Sales declined 0.6 percent from April, the Bureau of Statistics said in Sydney today, compared with the median forecast in a Bloomberg News survey of 24 economists for a 0.3 percent gain. Building permits were down 7.9 percent in the month.

The Australian dollar weakened to $1.0734 as of 12:29 p.m. in Sydney from $1.0770 on July 1 in New York. The two-year bond yield declined four basis points, or 0.04 percentage point, to 4.77 percent, according to Bloomberg data.

The spread between yields on 10-year government notes and similar-maturity inflation-indexed securities narrowed 11 basis points since May 31 to 2.86 percentage points today.

A measure of Australia’s annual inflation fell below the top of the central bank’s target range in June for the first time in 11 months as costs declined for automotive fuel and clothing.

Consumer prices rose 2.9 percent in the 12 months through June after a 3.3 percent advance for May, according to an index compiled by TD Securities Inc. and the Melbourne Institute released in Sydney today.

RBA’s Outlook

The central bank forecast growth in 2011 at 4.25 percent, in a May 6 policy statement, the fastest pace since 1999. Consumer prices will rise 3.25 percent over the period and core inflation will accelerate to 3 percent from 2.75 percent, it said. The RBA aims to keep inflation between 2 percent and 3 percent on average.

China’s non-manufacturing industries expanded at the slowest pace in four months in June, a report showed yesterday, adding to concerns that efforts to tame inflation are curbing growth in the world’s second-biggest economy.

A purchasing managers’ index dropped to 57 from 61.9 in May, the China Federation of Logistics and Purchasing said on its website yesterday. Signs in the report of a slowdown in the service, retail and catering industries add to evidence China’s growth is cooling, with data last week showing a manufacturing index fell to 50.9, its lowest level since February 2009. Readings above 50 indicate expansion.

China’s economic growth target for this year will be “very challenging” to achieve, Vice Premier Wang Qishan said yesterday. The ruling Communist Party, which celebrated its 90th anniversary last week, says taming inflation is the top priority in 2011. Premier Wen Jiabao said June 24 he is confident of keeping prices under control, while Morgan Stanley says inflation may have peaked at an estimated 6.2 percent last month, which would be the fastest pace since 2008.

Greece Concerns

Australian money markets have reversed course over the past month on concerns a Greek default would cause the biggest disruption to global financial markets since Lehman Brothers Holdings Inc. collapsed in 2008.

European finance ministers agreed over the weekend to disburse 8.7 billion euros ($12.7 billion) of loans under last year’s 110 billion-euro bailout by July 15, rewarding Greek Premier George Papandreou for pushing an extra austerity plan through parliament.

Cash-rate futures show a 30 percent probability the RBA will lower borrowing costs by year-end, compared with a 72 percent chance of an increase on June 1, according to contracts on the Sydney Futures Exchange. The futures had indicated a 100 percent chance of a rate cut by December on June 27.

The central bank increased its target rate by 175 basis points from October 2009 to November last year.

Australia is experiencing a surge in resource investment as mining and energy firms boost output to meet demand from China and India, two economies that account for more than a third of the world’s population. That’s bolstered demand for Australia’s dollar, the world’s fifth-most traded currency, which advanced 28 percent in the past year and reached $1.1012 on May 2, the highest since it was freely floated in 1983.

‘Further Tightening’

The currency jumped 2.7 percent last week, the biggest five-day climb since March.

Stevens, in a speech last month, reiterated that policy makers will need to raise rates at some stage and signaled inflation data on July 27 may be key for such a decision.

“Our most recent analysis, as published in early May, concluded that the underlying rate of inflation is more likely to rise than fall over the next couple of years,” Stevens said June 15. “This central expectation -- subject to all the usual uncertainties inherent in forecasting -- suggests, as we said at the time, that ‘further tightening of monetary policy is likely to be required at some point for inflation to remain consistent with the 2-3 percent medium-term target’,” the RBA Governor said in Brisbane.

The RBA has expressed concern that higher consumption will clash with capacity constraints such as skill shortages caused by mining investment that the government estimates will reach A$76 billion ($81 billion) this fiscal year.

Australia’s gross domestic product shrank 1.2 percent in the first quarter, the most since 1991, as floods that devastated slashed coal exports.

‘Softer Patch’

Investors are concerned the economy will take longer than expected to recover after a government report last month showed the number of full-time jobs fell by 22,000 in May after dropping 57,200 in April, the biggest two-month decline in more than two years. The jobless rate held at 4.9 percent.

“Our view is that the current softer patch is largely temporary, reflecting some transition dynamics for an economy that is becoming more mining sector dependent,” said Paul Bloxham, Sydney-based chief economist for HSBC Holdings Plc and a former RBA official. “But one cannot rule out the possibility that the slowdown is something more sinister, which is a risk to our central call of a hike in August and 100 basis points of hikes by mid-2012.”

Bond Yields

Australian 10-year bond yields fell three basis points today to 5.25 percent, clawing back some of last week’s 20-basis-point increase, the biggest five-day advance since March 2010. The premium over similar-maturity Treasuries narrowed to 206 basis points from 225 on Dec. 31.

The extra yield investors demand to hold Australian corporate debt rather than government securities climbed to 177 basis points on June 30, the widest spread since Feb. 21, and was 175 basis points at the end of last week.

Traders bet there is a 10 percent chance of a 25-basis-point rate cut in August and a 30 percent chance in October, 30-day interbank cash-rate futures show.

“Looking for a trigger to flatten this curve again there’s not going to be anything in the next three to four weeks,” said Annette Beacher, head of Asia-Pacific research at TD Securities in Singapore. “We really need to see some big numbers to focus back on the strong fundamentals for Australia.”

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