RBA Readies Downgrade to 2011 Growth as Rate-Rise Risk Eases

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

The Reserve Bank of Australia’s signal that it’s preparing a cut in its forecasts for growth reduces the chance Governor Glenn Stevens will add to the developed world’s highest borrowing costs before year-end.

Stevens held the overnight cash rate target at 4.75 percent in Sydney yesterday, the seventh straight meeting of inaction. He said the economy is unlikely to reach the RBA’s forecast of 4.25 percent growth this year as a resumption of coal exports from flooded mines takes longer than expected.

The central bank’s language brings it closer to the bond market, where interbank cash rate futures indicate a cut is more likely this year than the increase priced in a month ago. An extended pause would avert a bigger hit to retailers and the housing industry, which have been subdued by 175 basis points of rate increases from October 2009 to November 2010.

“This isn’t a central bank preparing the market for higher rates any time soon,” said Roland Randall, an economist at TD Securities Inc. in Singapore. “In the unlikely event that we see a shocking rise in core inflation the RBA would pull the trigger. More likely, we will see the RBA hold off.”

Dollar’s Drop

The Australian dollar fell against all its major counterparts following the decision, trading at $1.0697 as of 5:58 p.m. in Sydney yesterday from $1.0734 in New York a day earlier. Interbank cash-rate futures were pricing in a 46 percent chance of a rate cut in December. A month ago, they reflected 78 percent odds Stevens would raise rates by a quarter percentage point by the end of that month.

Stevens said in a June 15 speech that rates probably have to climb “at some point” as “the underlying rate of inflation is more likely to rise than fall.” Yesterday, he said consumer-price growth is expected to be near the RBA’s 2 percent to 3 percent target range in the next year.

Global commodity prices dropped in the three months ended June 30 for the first time in four quarters on concern China’s own attempt to slow inflation will curb demand for raw materials, the driver of Australia’s biggest mining boom.

Non-manufacturing industries in China, Australia’s biggest trading partner, expanded at the weakest pace in four months in June, a report showed this week.

Market Volatility

“The dampening effects of high commodity prices on income and spending in major countries have both contributed to the slowing” in global growth, Stevens said yesterday. “The banking and sovereign debt problems in Europe have also added to uncertainty and volatility in financial markets over recent months.”

Paul Brennan, a senior economist at Citigroup Inc. in Sydney, highlighted the tentativeness in the statement’s language on the medium-term economic outlook, using the qualifying phrase “if the world economy grows as expected.”

The Australian dollar has strengthened 27 percent in the past 12 months as investors bet Stevens will have to raise rates as mining companies including BHP Billiton Ltd. boost hiring to meet demand from Asia. In contrast, the U.S. Federal Reserve has held its benchmark rate near zero since December 2008.

“Cautious behavior by households and the high level of the exchange rate are having a noticeable dampening effect,” Stevens said yesterday. “Growth through 2011 is now unlikely to be as strong as earlier forecast. Over the medium term, overall growth is still likely to be at trend or higher, if the world economy grows as expected.”

Economic Contraction

Australia’s economy shrank 1.2 percent in the first quarter, the most since 1991, as floods in the northeast slashed coal exports. The nation’s recovery may be more prolonged after a report last month showed the number of full-time jobs fell by 79,200 in May and April, the biggest two-month decline in more than two years. The jobless rate held at 4.9 percent.

“A gradual recovery from the floods and cyclones over the summer is taking place, though the resumption of coal production in flooded mines continues to proceed more slowly than initially expected,” Stevens said. “The recovery will boost output over the months ahead, and there will also be a mild boost to demand from the broader rebuilding efforts as they get under way.”

Spending Weakens

Household spending accounts for 55 percent of Australia’s economy, and a report this week showed retail sales unexpectedly dropped 0.6 percent in May from a month earlier, the second drop in three months.

The RBA had expressed concern that higher consumption would 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.

The RBA said in quarterly forecasts released on May 6 that consumer prices will rise 3.25 percent this year and core inflation, which excludes the most volatile prices, will reach 3 percent.

Those estimates “can now be hidden away in a back room at the RBA, unmentioned and deliberately forgotten,” said Sean Keane, an analyst in Auckland at financial advisory group Triple T Consulting and former head of Asia-Pacific rates trading at Credit Suisse Group AG. Forecasts to be released in August “are likely to look very different,” he said.

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