Photographer: Brendon Thorne/Bloomberg

Strong Aussie Growth Hasn't Derailed Rate-Cut Bets

Updated on
  • Market still pricing in likely easing within next six months
  • Annual pace of economic growth accelerated to 3% last quarter

Stronger-than-expected Australian growth data has provided some vindication for the central bank’s choice this week not to ease policy any further. The market remains unconvinced Governor Glenn Stevens can maintain his balancing act.

While a report Wednesday showing the most robust calendar year of growth since 2011 helped validate last year’s labor market strength, it leaves unanswered the question of whether recent turmoil in financial markets will derail domestic activity. Swaps traders pared their bets on interest-rate cuts in light of the growth figures, but they were still pricing a better than 90 percent chance of a quarter percentage point cut in the next six months as of 11:58 a.m. on Thursday in Sydney.

The Reserve Bank of Australia opted on Tuesday to keep its key rate at 2 percent for a 10th month, citing “reasonable prospects for continued growth.” In contrast to the fourth-quarter economic output numbers, other indicators released in February painted a more sobering picture: companies’ annual investment plans fell to the lowest in nine years, wage growth was the weakest on record and a gauge of inflation expectations fell below zero.

Domestic Risks

“This makes the RBA a little more comfortable with leaving rates at hold,” said Michael Blythe, chief economist at Commonwealth Bank of Australia. “The big domestic risks of weak income growth and falling mining capex as the construction boom winds down are still playing out, but so far the domestic economy has been able to handle them pretty well.”

The following charts underscore some of the divergent factors influencing the economy and the RBA’s views as to what it should do next. Australia’s expansion is being accompanied by weak income and inflation pressures, which may be compounded by a strengthening currency. At the same time, even as financial market stress has driven up the risks associated with holding corporate debt, funding costs for companies remain at low levels.

CHART 1: While turmoil in global markets helped spur a blowout in credit spreads and bank funding expenses, the overall cost of borrowing for corporates remains cheap by historical standards as global monetary easing and investors’ desire for safer assets have underpinned a decline in interest rates.

CHART 2: The Aussie dollar traded at 72.89 U.S. cents on Thursday, 6.8 percent higher than the near seven-year low it reached Jan. 15. The gains have come even as the nation’s 10-year benchmark bond yield slid to as low as 2.315 percent on March 1, within seven basis points of the record 2.248 percent set in February 2015.

CHART 3: Australia’s economy may be growing, but it’s struggling with the most sluggish wage growth on record. Workers’ pay grew by just 2.2 percent in the year through December.