May 29 (Bloomberg) -- Australia’s central bank may need to cut record-low interest rates at least two more times as mining investment peaks and slowing growth in China damps exports, said Pacific Investment Management Co., manager of the world’s biggest bond fund.
With resources investment providing 60 percent of Australian economic growth last year, policy makers need to act to support other sources of domestic demand, Sydney-based portfolio managers Adam Bowe and Robert Mead said today. The Aussie dollar is still high enough to restrict the economy even after dropping to a 1 1/2-year low, they said.
“Australian and global policy rates are reconverging and the risks are that there are more rate cuts to come rather than less,” Bowe said today in a phone interview. “The single cut currently being priced in by the markets looks like it won’t be sufficient unless the exchange rate suffers a more meaningful correction than the current decline.”
The Reserve Bank of Australia indicated weak inflation gives it scope for further reductions after cutting its benchmark rate to 2.75 percent this month. Non-mining industries are struggling to take up the slack in the economy, damped by a currency that is more than 20 percent overvalued on a purchasing power basis. The government last week said the resources-investment boom may be at its peak as A$150 billion ($144 billion) of projects have been scrapped or delayed.
The Australian dollar has plunged 7.1 percent this month to 96.34 U.S. cents as of 12:40 p.m. in London, the steepest drop among the Group of 10 developed-mark currencies. It touched 95.28, a level unseen since Oct. 5, 2011.
“Certainly if the Australian dollar continues to decline that will take some pressure off the RBA, but the recent fall has just taken us back to the lows of the past couple of years, which still leaves the exchange rate very restrictive,” Bowe said.
The prospect of further support from fiscal spending is limited unless the government actively decides to increase debt, Pimco said. The bond manager sees revenue remaining subdued -- with national income growth already at low levels rarely seen outside of recessions -- keeping the federal budget in deficit for a couple of years. While housing could make a contribution to demand, it is likely to be modest, according to Mead and Bowe.
“Lower interest rates will likely be required to support domestic demand as Australia transitions away from mining-assisted growth,” Bowe and Mead wrote in a report published earlier today. “The New Normal has finally arrived down under.”
Pimco, based in Newport Beach, California, and managing more than $2 trillion of assets worldwide, popularized the phrase “New Normal” to describe an era of lackluster growth and lower returns in the world economy following the 2008 financial crisis.
The extra yield Australian government bonds offer over U.S. Treasuries may shrink further after reaching four-year lows, because Australia’s economy is slowing at the same time U.S. prospects are improving, Mead said.
“The recent narrowing in the premium Aussie bonds offer over Treasuries shows the market recognizing that potential growth rates have clearly converged,” Mead said by phone. “We think there is still room for that gap to tighten further.”
The gap between benchmark 10-year Australian yields and Treasuries has shrunk 15 basis points since April 30 to 127 basis points and touched 116 yesterday, the least since November 2008.
Pimco sees the need for additional incentives to help business investment in industries apart from mining, which have faced “considerable headwinds” over recent years, including a strong local currency and competition for labor and capital from the resources sector. Household consumption growth is already at trend rate and unlikely to take up the slack, while slowing growth in China, Australia’s biggest trading partner, could weigh on exports, Pimco said.
Standard Chartered Plc said today the RBA may lower rates again as early as next week.
“Further monetary impetus is essential to boost the economy,” the bank said in a note from analysts including Callum Henderson, Singapore-based head of currency research. “Inflation is benign and the recent Australian dollar move lower is not an impediment to further central bank easing.”
The Aussie’s retreat came too late to save Ford Motor Co.’s Australian unit, which announced this month it will pull out from car manufacturing nine decades after it started making Model Ts at Geelong, west of Melbourne. Ford Australia said its costs are double those in Europe and four times those in Asia.
The local dollar is still 23 percent higher against the greenback than differences in producer prices would suggest, making it the most overvalued after the kiwi among nine major currencies tracked on that basis by Bloomberg.
Australian consumer confidence slumped in May by the most in 17 months as a government announcement the budget would remain in deficit overshadowed record-low rates, according to a private report. The government in December abandoned a pledge to achieve a surplus this fiscal year and on May 14 projected a shortfall of A$19.4 billion.
The prospect of lower RBA rates is likely to drive gains for local bonds, Pimco said today.
“At these levels we are starting to see very good value come back into the five- to 10-year part of the Australian rates structure,” Mead said. “We maintain our preference for very high-quality spread products -- covered bonds, residential mortgage-backed securities and semi-government notes.”
Benchmark 10-year bond yields rose Australian 10-year rates rose 38 basis points since April 30 to 3.48 percent.
To contact the reporter on this story: Benjamin Purvis in Sydney at email@example.com