Australia Opts for More Easy Money

By Ari Charney • May 8, 2013 • Pacific Digest

In last week’s Down Under Digest, I noted that Australia’s low inflation gave the Reserve Bank of Australia (RBA) ample room to further lower its official cash rate. Nevertheless, the central bank’s decision yesterday to cut the cash rate by 25 basis points, to 2.75 percent, took most economists by surprise.

The RBA’s latest move was the fifth rate cut over the past 12 months, and the seventh overall since the cash rate’s post-recession peak at 4.75 percent. The cash rate is now lower than it was during the global financial crisis, when it bottomed out at 3 percent for six months in 2009. In fact, the rate is at its lowest level in more than 50 years.

Of course, even at this level, Australia’s cash rate is significantly higher than similar rates among its developed-world peers, many of which have set short-term rates at 1 percent or less. That’s because the RBA uses relatively higher rates to attract capital from overseas in an effort to offset its current account deficit.

The cash rate is a key benchmark for the country’s banking system and is equivalent to the US Federal Reserve’s federal funds rate. It’s essentially an effort to target the rate at which financial institutions lend to one another overnight. Since it governs the short-term liquidity of the entire financial system, the cash rate is one of the RBA’s most important levers for setting monetary policy.

RBA Governor Glenn Stevens noted the strong Australian dollar remains a key headwind for the country’s exports, with the exchange rate still at historically high levels despite a decline in export prices and interest rates. Since the central bank’s announcement, the Australian dollar has fallen 0.7 percent, to USD1.0171 from USD1.0238.

Stevens also mentioned the central bank’s intent to spur growth in non-resource sectors of the economy, as business investment in the resources space is expected to peak later this year. Finally, he described credit demand as having been “relatively subdued.”

Although a majority of economists had not anticipated a rate cut at this juncture, that hasn’t stopped them from predicting yet another cut of 25 basis points when the RBA’s board convenes next, in early June. Economists have observed that the central bank has a pattern of timing the adjustment of rates in pairs. Indeed, the bank has made such moves in consecutive months 14 times since 1990.

The cautious wording of Stevens’ announcement hinted that the bank’s board is already disposed toward additional easing should the average inflation rate remain at the low end of the bank’s target range of 2 percent to 3 percent:

The Board has previously noted that the inflation outlook would afford scope to ease further, should that be necessary to support demand. At today’s meeting the Board decided to use some (emphasis mine) of that scope.

One clue as to how the RBA’s board will rule in June could come from the Australian Bureau of Statistics’ report on expected capital expenditures, which is schedule to be published (at this link) on May 30. Analysts at Bank of America Merrill Lynch said that a weak result could portend another cut, especially if the April labor force report, which should be released tomorrow (at this link), is worse than expected.

Regardless, Bloomberg’s survey of swap contracts shows the financial markets are predicting at least two more rate cuts later this year. And Westpac Chief Economist Bill Evans believes the central bank could ultimately cut rates as low as 2 percent over the next 12 months.

Historically low interest rates should continue to spur income investors to pile into dividend stocks, pushing prices even higher. Among high-yield securities, analysts at RBS Morgans favor APA Group (ASX: APA, OTC: APAJF) and Telstra Corp Ltd (ASX: TLS, OTC: TTRAF).

The Roundup

For the latest information on our Portfolio Holdings, please see the forthcoming issue of Australian Edge, which should be posted to the website on the evening of Friday, May 10.

Here’s where to find discussion of earnings for AE Portfolio companies, most of which have 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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