Why the Case Is Building for Stevens to Relent on RBA Rate Cut

Australia’s central bank has kept its benchmark interest rate at a record low for 17 months -- the longest period on hold in almost two decades -- as the economy has gone from mining investment boom to bust.

A growing group of economists say it’s time to cut again.

The number anticipating a rate reduction in the first half of the year has grown to 11 of the 35 surveyed by Bloomberg News in Jan. 15-20, up from six out of 26 in December. They include three of Australia’s four major banks, the country’s largest investment bank and Deutsche Bank AG.

Reserve Bank of Australia Governor Glenn Stevens, who will hold the year’s first policy meeting on Feb. 3, has been reluctant to reduce the overnight cash rate target from 2.5 percent where it has been since August 2013. “I don’t think we see many people at all saying ‘look, the cost of money is too high, or I can’t get money,’” he said in an interview with the Australian Financial Review published Dec. 12 -- his most recent public comments.

Here’s why some economists think he will relent:

* The hoped-for transition away from mining hasn’t taken hold

Declining mining investment is a drag on growth that hasn’t been significantly offset by a pick up elsewhere in the economy apart from construction. Australian companies forecast A$86.3 billion ($71 billion) of such investment in the year through June, a drop of 17 percent from the same estimate a year earlier. Low interest rates have yet to ignite what Stevens calls the necessary animal spirits that drive firms to invest.

“The broadening of the non-mining recovery beyond housing and construction has been disappointingly slow,” Australia & New Zealand Banking Group Ltd. Chief Economist Warren Hogan said in a research note Jan. 15. “Weaker growth and lower inflation in 2015 will provide the RBA with a reason and the scope to take the cash rate down 50 basis points to 2 percent over the first half of the year.”

* Falling commodity prices mean a pay cut for the economy

An almost halving in the price of iron ore last year, which accounts for about a fifth of Australia’s export dollar, has meant a pay cut for the economy even as volumes shipped grow. Forecasts of a further fall in the terms of trade signal pressure for the Australian dollar to weaken and Stevens has said as much, nominating 75 U.S. cents as a preferable level in the interview with the AFR. It was trading at about 82 cents Jan. 21 in Sydney.

“We think a reluctant RBA will be forced to cut rates to push the currency to a point low enough to rotate demand back onshore,” Macquarie Group Ltd.’s head of economic research, James McIntyre, said in a research note Dec. 22. Outside of growth in mining exports and population, “Australia’s per capita economic wellbeing has gone nowhere over the past three years.”

McIntyre forecasts the RBA will cut the cash rate 50 basis points in the first quarter.

* Inflation is evaporating

A drop in oil prices of almost 50 percent last year is flowing through to lower gasoline prices and reduced costs for businesses.

“Falling inflation on the back of falling commodity prices and global spare capacity indicates deflation is more of a threat globally than a surge in inflation,” Shane Oliver at AMP Capital Investors Ltd. in Sydney said in a research note Jan. 21. “Low interest rates will remain, with further easing likely outside the U.S. and another RBA rate cut.”

AMP Capital forecasts the RBA will reduce the cash rate by 25 basis points in the first quarter.

* House-price gains are moderating

CoreLogic RP Data’s home price index rose 7.9 percent in December from a year earlier, the slowest pace since October 2013, and the country’s banking regulator said last month that lenders should limit mortgage growth to investors to 10 percent a year or it may take action against individual banks.

Signs of moderating house-price growth “combined with our forecast for the unemployment rate to move higher through 2015 and ongoing declines in commodity prices, have led us to change our view on the cash rate,” Deutsche Bank’s chief economist in Australia, Adam Boyton, said in a Dec. 2 note announcing the bank’s forecast change.

Deutsche expects a quarter-point cut in the cash rate in the second quarter.

* Consumers aren’t happy

An index of consumer sentiment rose 2.4 percent in January from December, yet remains 9.7 lower from a year earlier, Westpac Banking Corp. said Jan. 21.

“At 93.2 the index level indicates pessimists still outnumber optimists by a significant majority,” Westpac Chief Economist Bill Evans said in a press release accompanying the data. “We expect that by the time of the release of the inflation report next week the case for a rate cut will have been made.”

Evans expects the RBA to cut the cash rate 25 basis points on Feb. 3.

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