Low Inflation Guides Australia’s Easy Money

By Ari Charney • May 1, 2013 • Pacific Digest

Unlike the Bank of Canada, which famously lowered its overnight rate in anticipation of the global financial crisis, the Reserve Bank of Australia (RBA) initially boosted its cash rate twice in early 2008, by a total of 50 basis points, to 7.25 percent. As the economy weakened, however, the RBA slashed rates in a succession of aggressive cuts, until the cash rate stood at just 4.25 percent by the end of that year.

Australia’s central bank ultimately took its key rate as low as 3 percent in 2009, before economic recovery prompted a new cycle of modest tightening, to 4.5 percent. But with the global economy showing signs of a slowdown, the RBA started cutting again in late 2011 and eventually lowered its cash rate target to 3 percent, which is where it’s stood since last December.

So the good news is that RBA Governor Glenn Stevens, whose decision to raise rates in that fateful year was blamed for exacerbating Australia’s economic woes, is taking a far more accommodative stance this time around. That should partially offset some of the more significant headwinds facing the economy, including a slide in commodity prices, high labor costs, and the strong Australian dollar.

Although Australia’s economy grew 3.1 percent last year, which was largely in line with its long-term growth trend, the RBA expects gross domestic product (GDP) growth to drop to 2.5 percent this year, due to a weaker outlook for mining investment.

According to the Australian Bureau of Statistics (ABS), mining accounts for 10 percent of Australia’s industrial output and more than 40 percent of business investment. That means any contraction in the latter, which now represents 8 percent of GDP, is felt throughout the Australian economy. The RBA forecasts mining investment to peak this year, while non-mining business investment in areas such as machinery and equipment will likely remain subdued.

On the other hand, the Westpac Melbourne Institute Leading Index, which is used as an indicator of economic activity over the ensuing three-to-nine-month period, showed a reading of 4.2 percent in February. That’s an acceleration from the 2.7 percent reading in September and well above its long-term rate of 2.8 percent. Even so, Westpac believes that growth will be below trend in both 2013 and 2014.

Roughly two-thirds of the improvement from the September reading is due to the performance of Australia’s stock market as well as a rebound in commodities. However, some of the latter have experienced downward momentum in prices more recently, particularly iron ore.

The sluggish economy could put additional pressure on the RBA to provide further monetary easing by reducing its cash rate yet again. Fortunately, muted inflation gives the central bank plenty of room to do so. The RBA typically targets an average inflation rate of 2 percent to 3 percent.

Australia’s consumer price index (CPI) rose just 0.4 percent during the first quarter, or 2.5 percent annualized. That was well shy of consensus expectations of 0.7 percent for the quarter. Still, there were a few surprises, including a 1.7 percent rise in home prices, the highest since early 2008 just prior to the downturn. However, Westpac believes that performance will prove ephemeral, as it’s likely the result of government subsidies for first-time homebuyers.

In the minutes of the RBA’s April 2 monetary policy meeting, members noted that the rate-sensitive components of Australia’s economy appeared to be responding to historically low rates, though the broad economy still faces significant challenges. The RBA’s next board meeting is set for Tuesday, May 7.

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Here’s where to find discussion of earnings for AE Portfolio companies, most of which just reported fiscal 2013 first-half results. Some posted results for 2012, while others report on completely different schedules. We’ve included the next reporting dates for those companies. Please consult the Portfolio tables at www.AussieEdge.com for current advice.

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