RBA Cut Rate to Boost Business; Households Start to Respond

The Reserve Bank of Australia cut its benchmark interest rate to a record low this month to boost businesses weakened by the currency’s sustained strength, even as households reacted to earlier reductions.

“Conditions in the business sector, as assessed in surveys, generally had remained below average, possibly in part because the exchange rate had remained high,” the RBA said in minutes of its May 7 meeting released today in Sydney. “Increasingly, the household sector had shown signs of responding to” lower rates.

Governor Glenn Stevens and his board have slashed borrowing costs by 2 percentage points over the past 19 months to 2.75 percent, joining global counterparts in embracing record-low rates in an economy where inflation is contained, mining spending is predicted to crest, and credit growth stays subdued. Stevens aims to rebalance growth from mining regions in the north and west to builders and manufacturers in the south and east.

That task has been complicated by the local dollar’s surge from an October-2008 low that has hurt exporters and manufacturers, forcing them and others companies to adapt.

The Australian dollar remained “high by historical standards despite depreciating a little against most currencies,” the minutes said. “The bank’s liaison suggested that firms remained cautious about hiring staff.”

The so-called Aussie was at 98.10 U.S. cents as of 1:37 p.m. in Sydney, from 97.70 before the minutes were published.

Capital Inflows

This month’s rate cut, which the RBA today described as “appropriate to encourage sustainable growth,” followed the slowest core consumer price growth in 14 years in the first quarter. Business confidence also remains weak.

The previous low for Australia’s benchmark borrowing cost was 2.89 percent in January 1960, according to the central bank. Australia, which hasn’t recorded a current account surplus since 1975, typically maintains higher benchmark interest rates than other developed economies in order to attract capital inflows to offset its current account deficit.

“The effects of stimulatory monetary policy were continuing to emerge,” the RBA said. “Improved conditions in the housing market and strong population growth were also expected to support dwelling investment and household spending more generally.”

Home Prices

Australian home-loan approvals rose the most in four years in March, advancing 5.2 percent from the prior month, government data showed May 13. Retail sales had their biggest back-to-back gain in almost four years over the first two months of 2013, before falling 0.4 percent in March.

Australia’s currency, which didn’t rise above 85 U.S. cents between 1990 and 2006, hasn’t dropped below that level in almost three years. Its strength is helping damp import costs.

The inflation report for last quarter showed price declines were “widespread across items despite the relative stability of the exchange rate over the past couple of years,” the RBA said. “Members discussed the downward pressures on domestic costs and margins and the resulting declines in tradables prices, and whether these pressures would continue.”

The U.S., Europe and Japan have cut rates to a record to stimulate demand. Federal Reserve Chairman Ben S. Bernanke has kept the key U.S. rate near zero for more than four years, while European Central Bank President Mario Draghi earlier this month said policy makers are ready to cut again after reducing its benchmark to a record low 0.5 percent.

Economic Transition

Treasurer Wayne Swan said in the budget released last week that the government’s books wouldn’t be balanced until 2016. Treasury projected unemployment would rise to 5.75 percent by June 2014, from 5.5 percent last month, as the economy undergoes a “substantial transition” from resource investment to growth led by industries like housing construction.

The resources sector “is transitioning from the largest investment boom in our history to the ’production and exports phase,’” Martin Parkinson, secretary to the Treasury, said in the text of a speech to economists in Sydney today. “We do not expect the increase in resource production to be enough to offset the decline in resource investment. Accordingly, the net contribution of the resource sector to real GDP growth is expected to fall.”

As a result, non-resource sectors of the economy will need to pick up, he said. “This transition will be supported by low interest rates, but challenged by continued weakness in the global economy and a persistently high Australian dollar, even after the welcome falls in the past week,” he said.

Below Trend

The RBA said in the minutes that growth in economic activity was expected to be a little below trend this year, picking up gradually to be close to trend through 2014.

“The near-term forecast reflected the slowing in overall business investment, given the peak in the mining investment boom along with the effects of fiscal consolidation and the high level of the exchange rate,” the minutes showed.

The RBA has noted the continued strength of the currency, even as commodity prices fall. The nation’s economy has been boosted by a mining investment expansion to meet resource demand in emerging nations like China.

“Members noted that the nature of mining investment was changing,” the minutes showed. “There had been some pull-back in coal investment plans in the previous year and a significant amount of investment in iron ore projects had been completed. In contrast, a larger share of ongoing mining investment related to liquefied natural gas projects, which were based on long-term supply contracts. This characteristic implied less uncertainty about mining investment arising from volatility in commodity prices over the next couple of years.”

Traders are pricing in a 25 percent chance the central bank will lower borrowing costs by a quarter percentage point to 2.5 percent next month, according to interest-rate swaps data compiled by Bloomberg. The RBA’s next scheduled meeting is on June 4.

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