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Traders Are Betting Australia Has a Rate Cut Ahead

  • Market pricing in prospect of RBA easing within next 6 months
  • `They've got the door open,' with focus offshore, says RBC

For a central bank with an eye on financial turbulence, markets are showing enough distress to prompt traders to bet Australia will resume cutting interest rates in the next six months.

The probability of a quarter-percentage point reduction in the Reserve Bank of Australia’s 2 percent benchmark within the coming six months was at 96 percent as of 4 p.m. on Thursday in Sydney. Policy makers will update their forecasts for growth and inflation Friday, after highlighting in a rate decision Feb. 2 that recent market turmoil may be a trigger for additional easing if it dents global and domestic demand.

RBA Governor Glenn Stevens and his board are weighing signs of a strengthening labor market and within-target core inflation against the threat both will be derailed by crashing equity and commodity markets. Australia’s dollar -- a bellwether for risk sentiment -- has dropped 1.6 percent this year amid investor concern that global growth will be undercut by a slowdown in China and the U.S.

“The urgency around the policy debate is being provided by what’s going on offshore and we think they are still predisposed to cutting,” said Michael Turner, a fixed-income and currency strategist at Royal Bank of Canada in Sydney. “If you read that statement and they cut next month, you can’t exactly say that you weren’t warned. They’ve got the door open.”

RBC was among a minority predicting a cash rate below the current level in March, according to a survey of 29 economists conducted before this week’s RBA decision.

Declining Yield

Policy makers began reducing borrowing costs in late 2011 as the nation’s record mining investment boom began to unwind. They have so far cut rates by 2.75 percentage points, narrowing the bond yield premium investors can get by investing in Australia instead of the U.S. and causing a 30 percent slide in the local dollar.

The two-year benchmark sovereign yield was at 1.87 percent on Thursday having fallen to 1.82 percent the day before, a level unseen since Nov. 4. Australia’s dollar bought 71.70 U.S. cents after touching a seven-year low of 68.27 on Jan. 15.

RBA Watching

Stevens said Tuesday that the board will weigh a strengthening jobs market against the impact of recent global financial turbulence in deciding whether to ease policy further, while leaving the cash rate unchanged for an eighth meeting. Consumer price inflation will probably “remain low over the next year or two,” he said, omitting a prior forecast that it would be consistent with the RBA’s 2 percent to 3 percent target.

The RBA’s policy statement Tuesday was a touch more dovish than in December, but hawkish when compared with market pricing for at least one rate cut this year, said Adam Boyton, chief economist in Australia at Deutsche Bank AG, who predicts the bank will remain on hold.

“We’re probably in a world where global growth has disappointed a little bit over the course of the year where markets have been volatile,” he said. “Fortunately, it looks like we ended 2015 with a pretty robustly performing domestic economy, which means the RBA has a bit of time to sit and examine what these events mean for Australia.”

Growing Economy

Australia’s economy expanded 2.5 percent in the 12 months through September and employers last year added the most jobs since 2006 as the nation’s services sector prospered, helped along by a lower foreign-exchange rate. That currency weakness has continued in 2016 even as prices for Australia’s largest export, iron ore, stabilized above $40 a ton.

Still, markets may be signaling a turn for the worse. A gauge of global equities has dropped more than 1 percent in February, adding to the 6.1 percent slide last month, the biggest since August. These declines have come despite indications that central banks in Japan, China and Europe stand ready with additional stimulus measures if needed. Raw material markets have also fared badly, with oil declining and the Bloomberg Commodity Index sliding 2.7 percent since Dec. 31.

In addition, Australia’s economy has seen some proxy policy tightening take place as lenders attempt to recoup the increased costs of holding more capital due to tighter regulations. The nation’s biggest lenders increased mortgage rates for property investors in July and owner-occupiers in November, while National Australia Bank Ltd., the largest lender to businesses, raised some business lending rates this week.

China Risks

Chris Probyn, Boston-based chief economist at State Street Global Advisors, says that while Australia’s domestic fundamentals are “reasonably good” and the RBA is most likely to be on hold this year, a worsening of China’s situation could change that.

“Our view on Australia is that the RBA would be a reluctant cutter,” he said on Wednesday in Sydney. “The risks are probably skewed to the downside. We’re waiting to see where we end up with China.”

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