Rate-Cut Bets at 7-Week Low on RBA Optimism: Australia Credit

Reserve Bank of Australia Deputy Governor Ric Battellino
Ric Battellino, deputy governor of the Reserve Bank of Australia. Photographer: Ian Waldie/Bloomberg

Traders slashed bets on an interest-rate cut in Australia next month to the lowest level in seven weeks after the central bank showed optimism the nation will weather Europe’s debt crisis and a slowdown in the U.S.

Reserve Bank of Australia Deputy Governor Ric Battellino signaled Sept. 21 the economy should extend a two-decade expansion and that market pricing of rate cuts was “pessimistic.” Australia’s economy grew 1.2 percent last quarter, the fastest pace in four years, while an 11 percent decline in the currency against the U.S. dollar since July 31 may aid struggling industries such as manufacturing and tourism.

“The RBA would rather err on the hawkish than the dovish side as there are still pockets of strength in the economy, particularly if you look at the mining investment boom and growth in household disposable income,” said Pieter Van Der Schaft, head of Asian rates research at Morgan Stanley in Hong Kong. “With the decline in the Aussie dollar, financial conditions are easing somewhat so that is another reason for them to delay” any cuts.

The yield on October cash rate futures rose 16 basis points this month to 4.65 percent, compared with the 4.75 percent benchmark, the highest since Aug. 1 and on course for the biggest monthly increase since September last year. The cost to lock in fixed rates for three months in Australia rose 4 basis points since Sept. 19, the most in the Group of 10 currencies.

Consumer Spending

Australia’s gross domestic product expanded more than economists forecast last quarter, driven by rising consumer spending and a rebound in exports after natural disasters disrupted coal mining at the start of the year. Strategists expect growth of 1.84 percent this year and 4.25 percent in 2012, according to surveys by Bloomberg News.

The U.S., where employment growth unexpectedly stagnated in August, will expand 1.6 percent this year and 2.2 percent next year, while GDP in China, Australia’s biggest trading partner, will surge 9.3 percent and 8.7 percent, separate surveys show.

There are “reasonable grounds for optimism” that Australia’s economy won’t stall due to the slump in the U.S., Battellino said in a speech in New York.

Markets appear to have reached “a pessimistic assessment” based on the assumption U.S. and European economic problems will “flow through” to Australia, he told the Euromoney Australian and New Zealand Debt Capital Markets Forum. “The bank’s approach will be to keep an open mind.”

The RBA said in minutes of its Sept. 6 meeting released this week that it’s too early to gauge any effects of a U.S. slowdown and Europe’s debt crisis on other regions.

Mining Boom

The central bank raised interest rates seven times beginning in October 2009 to help control inflation amid the nation’s biggest mining boom in more than a century.

Chinese demand for Australian iron ore and coal help spur the Australian dollar to $1.1081 on July 27, the strongest since it was freely floated in 1983.

The currency’s 58 percent surge since the end of 2008 to its record curbed profits for companies in manufacturing and tourism with BlueScope Steel Ltd. and Qantas Airways Ltd. announcing plans last month to trim their workforces. The government will hold a conference Oct. 6 focusing on job creation, the future of manufacturing and “adapting to the high dollar,” Prime Minister Julia Gillard and Treasurer Wayne Swan said Sept. 11.

The so-called Aussie fell below parity yesterday for the first time in more than six weeks after a preliminary index of purchasing managers signaled Chinese manufacturing may shrink for a third month in September. It traded at 98.06 U.S. cents as of 12:55 p.m. in Sydney today.

Financial Turmoil

Clouding Australia’s outlook is concern the world’s largest economy is slowing and the global financial turmoil spurred by speculation Greece will default.

The Markit iTraxx Australia index of credit-default swaps on corporate debt climbed 23 basis points to 217.1 basis points yesterday, the biggest one-day jump since March 6, 2009 and the highest level since July 13 of that year, according to data provider CMA. The risk benchmark fell 3 basis points to 214 basis points as of 10:55 a.m. in Sydney today, according to Credit Agricole SA prices.

The extra yield investors demand to own the nation’s corporate bonds instead of similar-maturity government debt has increased 52 basis points this quarter to 229 basis points on Sept. 21, the highest since November 2009, Bank of America Merrill Lynch’s Australian Corporate and Collateralized Index shows. The spread was last at 228 basis points.

Investors are estimating Australian consumer prices will rise at an annual 2.46 percent pace over the coming five years, down from this year’s high of 3.14 percent on May 6, according to the gap between indexed government debt and bonds that aren’t linked to inflation.

Benchmark Yields

The 10-year benchmark government bond yield has tumbled 36 basis points this month to 4.01 percent at 1:02 p.m. in Sydney today. Yields on all Australian bonds, including the longest-dated security maturing April 2023, have been lower than the cash rate since Aug. 9.

The chance of the RBA lowering rates when it next meets on Oct. 4 fell to 46 percent today from 80 percent a week ago, according to a Credit Suisse Group AG index based on swaps trading.

Traders are wagering the central bank will cut rates to 4.01 percent by December, up from a low of 3.47 percent Aug. 9.

Morgan Stanley recommends paying the overnight indexed swap rate on expectations that the RBA won’t reduce rates at least till year end. The central bank may cut 50 basis points in the first half of 2012, Van Der Schaft forecasts.

“The key for them now is the employment outlook, particularly private-sector wage growth, and the fact that so far China’s economy remains strong and commodity prices are relatively firm,” he said.

The RBA will hold its key rate at 4.75 percent, according to 23 of 24 economists surveyed by Bloomberg News on Sept. 13. Sixteen expect the rate to be higher by the end of 2012, five expect it to be lower and three say it will remain unchanged.

“We still think the next move in the cash rate will be up,” said Helen Kevans, an economist in Sydney at JPMorgan Chase & Co. “The RBA’s made it pretty clear that they’re still worried about the medium-term inflation outlook, and provided things don’t deteriorate a lot more offshore, that will remain their focus.”

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