Australia: Rumblings of a Rate Cut

Earlier this year, Australian economy watchers were concerned that an overheated housing market and rising inflation might necessitate a hike in Australian interest rates. What they didn't count on was a global slowdown and the fallout from severe acute respiratory syndrome dimming the economic outlook and creating the need for a rate cut.

Such was the state of events that confronted the Reserve Bank of Australia when it met on May 6 to set the overnight policy rate, which has held at 4.75% since mid-2002. Real gross domestic product is expected to grow above 3% this year, compared with 3.8% in 2002. Analysts had expected policymakers to do nothing, because the data on the economy have shown more momentum in recent weeks than they did earlier in the year. In March, building approvals rose for the first time in three months, and retail sales climbed higher. And in April, consumer confidence jumped 11%, thanks to the end of the war in Iraq and a fall in energy prices.

The fall in fuel costs, coupled with a drop in food prices and a stronger Aussie dollar, set the stage for slower inflation, which grew at a worrisome pace during the Australian summer. Total consumer prices rose 1.3% in the first quarter from the fourth, or about 3.4% from a year ago.

That's above the RBA's inflation target of 2% to 3%. But with inflation expected to slow, the bank can concentrate on economic growth. One concern is how the weakness around the globe is hurting Aussie exports, which make up about one-fifth of the economy. The major markets for Australian exports, Japan and the U.S., have not rebounded as strongly as anticipated this year.

In addition, the SARS epidemic in Asia is hurting exports as well as tourism, another key industry. Although Australia has only four cases of SARS and no deaths so far, RBA Deputy Governor Glenn Stevens has warned that the disease will have a "dampening impact" on the economy. The slowdown could give the RBA another reason to cut rates by yearend.

By James C. Cooper & Kathleen Madigan

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