Stevens Says Inflation Data Still Gives RBA Scope to Ease

Australia’s central bank Governor Glenn Stevens said second-quarter inflation data suggests there’s still room to lower interest rates if required and that he wouldn’t be surprised if the currency dropped further.

“Recent inflation data do not appear to have shifted” the Reserve Bank of Australia’s assessment that the outlook for prices may “afford some scope to ease policy further if needed to support demand,” he said today in the text of a speech in Sydney. “The recent decline in the exchange rate seems to make sense from a macroeconomic perspective. It would not be a major surprise if a further decline occurred over time.”

The Australian dollar dropped as traders added to bets the RBA will reduce the benchmark rate by a quarter percentage point at next week’s meeting, adding to 2 percentage points of reductions since November 2011. The RBA had left the cash rate unchanged at a record-low 2.75 percent for the past two meetings as the currency slid 12 percent last quarter, easing pressure on the economy.

“An August rate cut would appear more likely than not,” Adam Boyton, chief economist for Australia at Deutsche Bank AG in Sydney, said in a research report after the speech. “The speech sketches a ‘modest’ outlook for the economy.”

The currency, which held above $1 from mid-June last year to May 9, traded at 90.85 U.S. cents at 3:03 p.m. in Sydney today, from 91.60 cents before the speech was released. The yield on two-year government debt fell to 2.34 percent, the lowest in a year, as swaps traders bet there’s a 94 percent chance the RBA will lower its benchmark rate on Aug. 6.

Shifting Portfolios

“One of the things we have been watching for as we have been reducing interest rates has been an indication of savers shifting portfolios towards some of the slightly more risky asset classes, as that is one of the expected and intended effects of monetary policy easing,” Stevens said today. “There are clearly signs of policy working in this respect, though not, to date, by so much that we see a serious impediment to further easing, were that to be appropriate.”

Australia’s economy has been driven by a mining investment expansion to meet demand in emerging nations including China. The central bank is aiming to rebalance the economy toward employment-intensive industries including residential construction as the investment boom wanes and China’s outlook remains clouded. Government data today showed Australian building approvals slumped 6.9 percent in June from a month earlier.

‘A While Off’

“Business capital spending outside the resources sector has been subdued; housing investment likewise has been on the low side,” Stevens said today. “There is ample scope for both to rise. This is by no means a certainty though and while there are signs of an increase in dwelling investment getting under way, a stronger trend in non-resources business investment looks like it is a while off yet.”

Government data showed last week that Australia’s core inflation remained below the midpoint of the central bank’s 2 percent to 3 percent target in the second quarter compared with a year earlier.

Asked in the question-and-answer session after the speech about the impact on inflation of the falling Australian dollar, Stevens said the RBA’s inflation targeting framework has sufficient flexibility and credibility.

“Swings in the exchange rate, we’ve had some quite big ones in recent years, and I think it’s unlikely that they’re going to derail us seriously on inflation,” he said. “I don’t think we’ll have too many dramas on that front, short of a very, very large depreciation.”

Syrian Pound

The Aussie retreated 12 percent in the three months through June, the biggest slide worldwide behind the Syrian pound, after the RBA cut rates in May and U.S. Federal Reserve Chairman Ben S. Bernanke signaled for the first time on May 22 that a tapering of bond purchases that have devalued the greenback may be on the cards as the world’s largest economy strengthens.

“Achieving the sort of growth we aspire to has become more difficult,” Stevens said today. “Average output growth has been lower over the past five years in Australia, as it has in all other advanced economies. Moreover, the challenges ahead are substantial and will require the appropriate responses.”

Resources Peak

Australian “resource sector investment rose from an average of about 2 percent of GDP, where it had spent most of the previous 50 years, to peak at about 8 percent,” Stevens said today. “That big rise is now over, and a fall is in prospect, with uncertain timing. It could be quite a big fall in due course.”

Australia’s unemployment rate rose to 5.7 percent in June, the highest since 2009, as full-time jobs declined in the month, according to government data. Consumer confidence slid in July and business conditions slumped in June, private reports showed this month.

“It is somewhat concerning that the business community’s confidence has been quite subdued in recent times,” Stevens said today. “To the extent that substantial structural change has been occurring, and there is inevitable uncertainty over the international outlook, it is quite understandable that some business segments have found the going hard and don’t feel very confident. Moreover, the phase shift of the mining boom itself is dampening confidence in some areas.”

China Concern

In China, Australia’s biggest trading partner, most provinces reported first-half growth below annual targets that in some instances were already lower than last year’s goals, underscoring the breadth of the nation’s slowdown.

The statistics highlight the risk of China missing the year’s nationwide 7.5 percent expansion goal as official concern over local-government financing threatens to curb funding for investment.

Australian Prime Minister Kevin Rudd, who is due to call an election by the end of November, has altered the government’s economic message since ousting predecessor Julia Gillard in June. He’s selling himself as the best leader to steer Australia through a downturn as Chinese demand wanes, and voters are responding, with the ruling Labor party drawing level with the opposition in some opinion polls.

“This speech marked the first occasion when the RBA seems to have declared that mining investment is now passed its peak,” said Paul Bloxham, chief Australia economist at HSBC Holdings Plc in Sydney and a former RBA economist. “We expect the RBA to cut the cash rate next week, although this is somewhat conditional on the level of the Australian dollar in coming days.”

Before it's here, it's on the Bloomberg Terminal.