RBA Holds Key Rate as Economy Withstands Global Slowdown

Australia Holds Key Rate as Economy Withstands Global Slowdown
The central business district is seen illuminated at dawn alongside the Harbor Bridge in Sydney, Australia. Photographer: Ian Waldie/Bloomberg

Australia maintained the highest benchmark interest rate among major developed economies as domestic demand weathers a global slowdown that’s driving down the price of iron ore, the nation’s biggest commodity export.

Reserve Bank of Australia Governor Glenn Stevens and his board left the overnight cash-rate target at 3.5 percent, according to a statement today in Sydney. While domestic consumption was “quite firm” in the first half of the year, commodity prices have fallen “sharply” in recent months and China’s growth outlook is more uncertain, he said.

In Australia, “growth has been running close to trend, led by very large increases in capital spending in the resources sector,” Stevens said. “Labor market data have shown moderate employment growth, even with job shedding in some industries, and the rate of unemployment has thus far remained low.”

The currency rebounded from near a six-week low after the decision as investors pared bets on rate reductions. While Europe’s fiscal crisis is weighing on global growth and Chinese demand, Stevens’s 75 basis points of cuts in May and June helped spur domestic spending and stabilize the housing market in an economy that’s avoided a recession for 21 years.

“It is clear that the Reserve Bank is happy to remain on the interest rate sidelines,” said Savanth Sebastian, an economist in Sydney at a unit of Commonwealth Bank of Australia. “Policy makers seem comfortable with domestic economic conditions but continue to watch the global situation carefully. Europe, the U.S. and Asia have slowed and the central bank seems particularly focused on the slowdown in China.”

Chinese Demand

Resource investment to meet Chinese demand and foreign investment funds seeking a haven have spurred gains in the nation’s currency, which closed above parity with the U.S. dollar for all but 23 days this year. The so-called Aussie has averaged $1.0246 in the past two years, compared with 72 U.S. cents in the prior decade.

Stevens said the local dollar’s strength was greater than the central bank anticipated. “The exchange rate has declined over the past month or two, though it has remained higher than might have been expected, given the observed decline in export prices and the weaker global outlook,” he said.

The local dollar strengthened after the decision, buying $1.0277 at 3:34 p.m. in Sydney compared with $1.0232 before the release. The decision to hold for a third straight meeting was predicted by all 24 economists surveyed by Bloomberg News.

Rate Outlook

Investors are pricing in a 42 percent chance the benchmark rate will remain at 3.5 percent next month, up from 30 percent yesterday, swaps trading data compiled by Bloomberg showed.

BHP Billiton Ltd.’s decision last month to delay approval of an estimated $33 billion expansion of the Olympic Dam copper, uranium and gold mine sparked suggestions the resources boom that has powered Australian growth is over.

A quarter of Australia’s exports, or about 5 percent of gross domestic product, goes to China, and 60 percent of those shipments are iron ore.

“Growth in China remained reasonably robust in the first half of this year, albeit well below the exceptional pace seen in recent years,” Stevens said in today’s statement. “Some recent indicators have been weaker, which has added to uncertainty about near-term growth.”

Fortescue Metals Group Ltd., Australia’s biggest iron ore producer after Rio Tinto Group and BHP, said today it’s cutting its full-year capital spending forecast by 26 percent to $4.6 billion.

Commodity Slump

Australian commodity prices declined 4.3 percent in August from the prior month and 18.5 percent from a year earlier in Australian dollar terms, a central bank index showed this week. The gauge reached the lowest level since April 2010.

“Some commodity prices of importance to Australia have fallen sharply in recent weeks,” Stevens said today. “The terms of trade peaked a year ago and have declined significantly since then, though they remain historically high.”

On the global economy, the central bank’s assessment is that it will grow this year at average pace at best, “with risks to the outlook still on the downside,” Stevens said. “Economic activity in Europe is contracting, while growth in the United States is only modest,” he said.

The Australian economy probably expanded 0.7 percent in the second quarter from the prior three months for the strongest first half of growth since 2007, a Bloomberg News survey of economists showed before a government report on second-quarter GDP tomorrow.

Tame Inflation

Stevens said the central bank’s assessment is that inflation will be consistent with its 2 percent to 3 percent target on average over the next one to two years.

“Maintaining low inflation will, however, require growth in domestic costs to remain contained as the effects of the earlier exchange rate appreciation wane,” Stevens said.

Australia’s unemployment rate has remained in a range of 5 percent to 5.3 percent for the past 15 months. The economy added jobs in four of the past five months and unemployment declined to 5.2 percent in July from a revised 5.3 percent in the prior month. A report on employment in August is scheduled for release Sept. 6.

The country’s central bank lowered borrowing costs by 1.25 percentage points from November to June to help shield the economy from Europe’s debt crisis and slower growth in China.

Housing Market

“As a result of the sequence of earlier decisions, interest rates for borrowers are a little below their medium-term averages,” Stevens said today. “The impact of those changes is still working its way through the economy, but dwelling prices have firmed a little and business credit has picked up this year.”

Traders are pricing in about an 80 percent chance that the RBA will lower borrowing costs by at least another 50 basis points by year-end to 3 percent, matching the 50-year low the benchmark reached at the height of the global financial crisis that started in 2008.

“We believe the bank is falling behind the curve, and with the retarding impulse of a global trade shock in the offing, the bank will be chasing that curve lower in the fourth quarter,” said Glenn Maguire, principal of Asia Sentry Advisory Pty Ltd. in Sydney. “The bank now seems likely to make haste quickly on rate cuts through the fourth quarter.”

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