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Will Australia Gift Markets a Christmas Rate Cut?

Sunday, 2 Dec 2012 | 11:19 PM ET
Opera House in Sydney, Australia.
Ken Ross | Taxi | Getty Images
Opera House in Sydney, Australia.

After holding fire in November, Australia's central bank is expected to lower borrowing costs when it meets on Tuesday, as the economy begins to show cracks.

The Reserve Bank of Australia (RBA) is likely to cut the benchmark interest rate by 25 basis points to 3 percent as both the mining and non-mining sectors of the economy threaten the country's growth outlook.

Data released on Monday showed retail sales were flat in October, against forecasts for a rise of 0.4 percent, as consumers cut spending on household goods. The slowdown in the economy has also led to a fall in job advertisements, which dropped 2.9 percent in November – the eighth straight month of declines.

On the resources front, the Australian Bureau of Statistics' latest capital expenditure survey released last week showed miners have slashed their business investment plans for the financial year ending June 2013 by more than 8 percent, compared to three months ago.

Mining investment plays a critical role in Australia's economy, accounting for more than half of the country's growth in gross domestic product (GDP) in 2011.

"The overall investment outlook now looks weaker than previously thought and, in our view, adds to the case for further RBA policy easing. We expect the cash rate to be lowered by 25 basis points," wrote Dylan Eades, economist at Australia and New Zealand Banking Group.

Kieran Davies, economist at Barclays, added that the capital expenditure survey points to a smaller peak in mining investment than originally forecast by the RBA.

Mining investment now looks likely to peak at about 7 percent of GDP in 2012-13 rather than the 8 percent peak the central bank had envisaged, he said.

"We think the bank will want to make sure that the rest of the economy is on a firmer footing after the resources-led boom in capex (capital expenditure) peaks at a lower level than previously thought next year," wrote Davies. According to the bank, the market is currently pricing in a roughly 70 percent chance of a 25 basis point rate cut.

The RBA has lowered rates by 100 basis points since May, with the last move being a 25 basis point cut in October to 3.25 percent.

Davies said there are signs that earlier rate cuts were working their way into the economy, pointing to stabilization in the housing market. However, he added that in order for the central bank to keep up momentum in the economy as the mining sector "returns to earth" next year, now is the best time to cut rates as monetary policy easing takes time to filter through into the economy.

Growth Slowdown

Last month, the RBA trimmed its 2013 GDP forecasts – to 2.25-3.25 percent from 2.5-3.5 percent citing lower commodity prices, falling mining investment and spending cuts – as part of the government's pledge to deliver a budget surplus next May.

Paul Bloxham, economist at HSBC, who also expects a 25 basis point cut at the upcoming policy meeting said, "With CPI (Consumer Price Index) still expected to be in the target band, lower expected growth should motivate further rate cuts."

The country's consumer price index rose 1.4 percent in the three months to September from the previous quarter. The RBA has a target range for annual inflation of 2-3 percent.

Australia is scheduled to deliver its third quarter GDP numbers on Wednesday, where growth is forecast to have slowed to 3.2 percent year-on year, according to a poll by Reuters, compared to 3.7 in the second quarter.

By CNBC's Ansuya Harjani