Australia Holds Rates as Currency Eases Commodity Price Rout

  • Change of prime minister may speed up economic reform program
  • Medium-term potential growth likely around 2.5% vs 3.25%: IMF

Australia left interest rates unchanged Tuesday after the local dollar recorded the biggest drop among major currencies last quarter, cushioning the impact of lower commodity prices and a weaker outlook in key trading partner China.

In a largely unchanged statement, Reserve Bank of Australia Governor Glenn Stevens and his board kept the cash rate at a record-low 2 percent, as predicted by markets and economists, following reductions in May and February. The currency dropped almost 9 percent in the June-September period.

Stevens reiterated that there had been “some further softening in conditions in China and east Asia of late” and that the “Australian dollar is adjusting to the significant declines in key commodity prices.”

Australia has so far had little success in stimulating industries with rate cuts outside of real estate as a decade-long mining investment boom unwinds. Businesses plan to cut investment by 23 percent this fiscal year as firms decide they can meet demand from heavily indebted households with existing capacity.

Firmly On Hold

The lack of change in the statement “tells you they’re pretty firmly on hold unless something really material changes,” said Stephen Walters, chief Australia economist at JPMorgan Chase & Co. in Sydney. “Clearly what we’ve seen over the last month wasn’t enough, which was a bit of weakness in China and maybe some extra volatility in financial markets.”

JPMorgan forecasts a further fall in the Australian dollar, which is the RBA’s “preferred method of easing up conditions,” Walters said. The currency edged higher after the statement, trading at 71.18 U.S. cents at 3:19 p.m. in Sydney from 70.83 cents before the decision.

China’s slowdown has intensified pressure on the Australian government to overhaul the tax system and labor market and boost competition to improve productivity and generate growth. The ousting of change-averse Prime Minister Tony Abbott in favor of Malcolm Turnbull, who declared he would provide the economic vision and leadership the country needed, may herald the beginning of a reform drive.

“Crazy” Property

One area where cheap borrowing costs have worked is the property market: prices in Sydney have soared and Stevens has described parts of the market as “crazy.”

“Dwelling prices continue to rise strongly in Sydney and Melbourne, though trends have been more varied in a number of other cities,” Stevens said. “Regulatory measures are helping to contain risks that may arise from the housing market.”

Traders are pricing in a more than 40 percent chance of another rate cut by December as Australia, the developed world’s most China-dependent economy, struggles to cope with slumping prices for key resource exports.

Yet the country’s labor market has remained relatively resilient, aided by weaker wages growth. Unemployment was 6.2 percent in August as more than 17,000 jobs were added.

“While growth has been somewhat below longer-term averages for some time, it has been accompanied with somewhat stronger growth of employment and a steady rate of unemployment over the past year,” Stevens said. “Overall, the economy is likely to be operating with a degree of spare capacity for some time yet, with domestic inflationary pressures contained.”

Similar to the U.S., debate is intensifying Down Under on whether potential growth is lower than earlier thought. Australia’s economy expanded 2 percent in the second quarter from a year earlier and has grown at below its average rate for six of the past seven years.

Australia’s medium-term potential growth is likely to be around 2.5 percent compared with 3.25 percent in the past, the International Monetary Fund said in a report last week. The RBA’s monetary policy is “appropriately accommodative and could be eased further if the cyclical rebound disappoints, provided financial risks remain contained,” IMF executive directors said in a Sept. 30 statement.

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