Bets Are Off for Future RBA Rate Cuts, But Keep One Eye on China

  • Lowe signals tolerance for weak inflation in Tuesday decision
  • Traders pare bets for 2017 rate cut to maximum one-in-three

Australian central bank Governor Philip Lowe gave his clearest sign yet he’s not hankering to cut the nation’s record-low cash rate.

Lowe’s upbeat economic growth outlook Tuesday combined with a concession that house prices in some markets had been “rising briskly” signals he’ll be unwilling to cut again and risk stoking property values further. That spurred money markets to pare bets for easing through the end of 2017 to a one-in-three chance. The upshot: it will take more than just low inflation to draw another policy response.

The most likely trigger would come from top trading partner China. While the Reserve Bank of Australia’s new chief noted that the world’s second-largest economy “steadied recently,” he warned that medium-term risks remain. Chinese authorities are trying to steer growth toward consumption and services, and away from heavy investment and construction where stimulus can be turned off and on at will. There’s also the matter of the nation’s mountain of debt.

Australia still faces a long, hard slog. While the RBA said Tuesday the economy will grow at close to its speed limit in the coming year, before strengthening, that’s unlikely to spur inflation as quickly as it might have in the past. A large chunk of expansion is coming from increased exports as new mines come online, requiring relatively little labor.

On top of that, given the decline in labor force participation and the rise of the part-time worker this year, the jobs market is probably looser than a 5.6 percent unemployment rate would normally suggest.

Still, the 230 percent surge in the coking coal price this year and a near 50 percent gain in iron ore are unexpected boons that will inject cash into the economy. Lowe pulled his punches on commodities in the statement -- reflecting some economists’ caution the rally will prove short-lived. Having said that, it’s already proved more durable than some predicted.

Stronger Aussie

The downside to the commodity jump is the stronger exchange rate accompanying it: the Aussie is the best performing Group of 10 currency since the end of June. An expected tightening by the Federal Reserve next month may take some steam out of the local dollar.

One missing factor the RBA still wants to see is businesses finally opening their wallets. With households burdened by record debt and the government trying to restore its fiscal position, companies are best positioned to unleash spending. Should the dam burst and firms start investing, then perhaps talk of policy tightening in Australia could begin.

But a shock will almost certainly be needed to push the 1.5 percent cash rate down any further.

“The inflation outlook is unlikely to be the source of any future policy adjustment,” said Bill Evans, chief economist at Westpac Banking Corp. in Sydney, who sees rates on hold next year. Growth and the labor market would need to “profoundly disappoint” to prompt further easing, he said.

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