Few central bankers in modern history have had a better run than Australia's Glenn Stevens. He steered his country around the global financial crisis, drove its currency to record highs and extended its recession-free run past the two-decade mark.
That's all in jeopardy now, however, as Stevens, governor of the Reserve Bank of Australia, stands still while China's slowdown and deflationary forces close in. Markets are registering their disappointment by driving the Aussie dollar below 80 U.S. cents for the first time since 2009. The message from traders: It's time for a rate cut. The question is, will Stevens act ahead of, or at, the central bank's Feb. 3 policy meeting?
The odds he will are rising, but remain too low for comfort. The European Central Bank’s quantitative-easing program and the Bank of Canada’s surprise rate cut add to the pressure on Stevens to trim a benchmark rate he's held at 2.5 percent for 17 months.
The most immediate danger is China, to which commodity-rich Australia has increasingly hitched its fortunes. The collapse in global commodity prices challenges Beijing's claim that its economy is growing 7.3 percent. Even more than the plunge in crude oil, iron ore at its lowest price in more than five years suggests China is growing slower. Such metals fuel the Chinese urbanization trend that's been lifting world growth. As Premier Li Keqiang explained at Davos this week, China's move to a consumer-led economy from an investment-led one is real, and the fallout will be felt everywhere. China's "new normal" is particularly bad news for Australia's mining industry.
“People are covering their eyes and refusing to believe that what is happening now is not just a cyclical story, but also a structural story,” economist Dong Tao of Credit Suisse told Bloomberg News.
As Goldman Sachs and others call an end to the commodities supercycle, the Australian government's fiscal policies are anachronistic. Prime Minister Tony Abbott's efforts to trim the budget deficit are out of sync with a deflationary world. The nation's 2.7 percent growth rate has lulled the Canberra establishment -- and, unfortunately, the central bank -- into a dangerous complacency.
Though the ECB's bond-buying dominated the week, the more important action for Australia came in Canada, a fellow "commodity currency" nation. Its Jan. 21 move to cut its benchmark rate a quarter of a percentage point to 0.75 percent "led to a mini-explosion in speculation" that Australia might be next, says Nick Parsons of National Australia Bank. And rightly so, considering that Australia's key rate is at least 1.25 percentage points higher than that of any other major developed economy outside New Zealand.
Central bank policy must lead economic dynamics, not follow them. Today's 2.3 percent inflation rate in Australia leaves Stevens reluctant to ease policy. But more important is where prices are headed six to 12 months from now. Here, events in Singapore may be instructive. (For the Asia region, its small but open economy often acts a weathervane.) At the moment, Singapore -- where consumer prices fell 0.2 percent in December -- points to deflation ahead.
Stevens should be preparing Australia for its arrival. Why isn't he? Perhaps it's the RBA's strict mandate to keep inflation between 2 percent and 3 percent. Or the same doctrinaire fear of overheating that has central banks from Seoul to Jakarta maintaining tight policies. But these blind spots can cause even the best central bankers to lose their way in this fast-changing world. Stevens must get his bearings to avoid a big policy mistake.
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