Australia central bank acting like it 'just woke up'

Lots more RBA cuts coming: Rabobank
Lots more RBA cuts coming: Rabobank   

Australia's record low interest rates are about to head way lower, analysts tell CNBC, as the country's central bank scrambles to play catch up in the race to the bottom for borrowing costs.

"The RBA (Reserve Bank of Australia) is acting as if someone slipped tranquilizers into their drink 18 months ago. They've just woken up and they're looking [at] the world around them and they're only gradually coming to terms with what they can see," said Michael Every, head of Asia-Pacific markets research at Rabobank.

The RBA chopped interest rates by a quarter-point on Tuesday to a historic low of 2.25 percent, surprising most economists but not the debt markets, which had priced in a 60 percent chance of a cut.

The central bank gave no hint that further easing is imminent, minutes from the meeting released Friday showed, although it did revise its 2015 growth forecast downwards to 1.75-2.75 percent, from 2-3 percent previously. Its less-than-dovish tone gave the Australia dollar a fillip against the U.S. dollar, rising to $0.7860.

No choice but to cut

But Every believes the RBA will have no choice but the bring rates even lower, with central banks the world over going on a monetary loosening spree. China, India, Russia and Canada are just a handful of major economies that have surprised with rate cuts this year. This alongside Switzerland's shock decision to remove its currency floor while moving interest rates into negative territory, and European Central Bank's widely expected decision to finally embark on a bond-purchasing program, or QE, to revive the euro zone economy.

By contrast, Australia hasn't seen changes to its monetary policy since the RBA last cut interest rates back in August 2013.

Analysts at Jefferies described in a note that the RBA's rate cut this week as "belated," and "not necessarily a surprise, [as] it came after the RBA had been on hold for 18 months."

Office employees are reflected in the Reserve Bank of Australia's wall in the central business district of Sydney, Australia.
Saeed Khan | AFP | Getty Images
Office employees are reflected in the Reserve Bank of Australia's wall in the central business district of Sydney, Australia.

"What the RBA is finding is that they're being dragged into a currency war," said Every, who expects another 75 basis points worth of rate cuts in the current easing cycle. "Australia is vastly uncompetitive, I don't think they want to openly say it, which is why they put a lot of fudge and nonsense in the minutes today and finally rates will come down further."

The badly-weakened Australian dollar may be helping to boost competitiveness, but not enough, some say. The Aussie has lost about 17 percent against the U.S. dollar since last June, in tandem with collapsing oil prices.

"The one thing that is crystal clear is that actually the Aussie dollar is still overvalued. Yes we're on 78 cents, but you look at it on a trade weighted basis, we're unchanged over a year and we're actually well about the long run trend," Every said.

Ring fence housing market

The RBA does face the tricky balance of ensuring that the booming housing market does not reach bubble levels, analysts say, given the flood of liquidity hitting markets.

"We know that the Aussie housing market, frankly, is on a different kind of drug not tranquilizers, very much the opposite," said Every. "They (policymakers) have to ring fence the housing market… and they've taken a tentative step towards that direction," he added, referring to the guidelines revealed by the Australian Prudential Regulation Authority last month to cool the real estate sector.

According to Paul Bloxham, chief economist for Australia and New Zealand at HSBC, the housing sector is the biggest challenge for the RBA at this point.

"The housing sector has already been booming, house prices are up year-on year," he said. "Has the RBA delivered low enough rates to deliver the housing sector into bubble territory?"