Australia Central Bank Cuts Rate to Record Low

Sydney Harbour, Australia
Image Source | Getty Images
Sydney Harbour, Australia

Australia's central bank cut interest rates a quarter point to a record-matching low on Tuesday, stepping up efforts to safeguard the rich world's most resilient economy from the risk of recession as a mining boom peaks.

The Reserve Bank of Australia (RBA) cut its main cash rate to 3 percent following its monthly policy meeting, bringing the easing since May to 125 basis points and matching the trough hit during the darkest days of the global financial crisis.

"While the full effects of earlier measures are yet to be observed, the Board judged at today's meeting that a further easing in the stance of monetary policy was appropriate now," said the central bank's governor, Glenn Stevens.

"Looking ahead, recent data confirm that the peak in resource investment is approaching. As it does, there will be more scope for some other areas of demand to strengthen."

Financial markets were almost fully priced for an easing given signs the seven-year old bonanza in mining investment is finally likely to crest next year, leaving a hole in growth that needs to be plugged by other sectors of the economy.

The move was so well discounted the local dollar actually firmed a quarter of a cent to $1.0445 on the news.

Yet, investors are still wagering official rates will have to go lower yet to truly stimulate demand among cautious consumers and a lacklustre housing market.

Interbank futures suggest the central bank rate could approach 2.5 percent by the middle of next year, while some economists think a floor of 2 percent is not impossible.

"I think the RBA realizes it needs to do more to boost the non-mining parts of the economy," said Shane Oliver, chief economist at AMP Capital Investors in Sydney.

"What it doesn't do is to offer much guidance as to the future, but my feeling is they still have to cut further. They will probably do 25 (basis points cut) in February and then 25 in April."

One reason for that is the stubborn strength of the Australian dollar.

In the global financial crisis, the currency tumbled by 30 U.S. cents, giving a big boost to exports. This time foreign demand for Australia's triple-A rated debt has helped it stay solidly above parity.

China has also played a part by accepting more moderate growth at home and thus restraining demand for Australia's commodity exports,leading top miners such as Rio Tinto and BHP Billiton to announce a slowdown in future expansion plans and job cuts.

The Asian giant is Australia's biggest trade market and the single largest buyer of iron ore.

It helped Australia avoid recession during the global crisis by unveiling a 4 trillion yuan ($635 billion) stimulus package that led to a wave of infrastructure development and demand for resources.

Australia's mining investment in the year to June 2013 is expected to total A$109 billion ($113.6 billion), or nearly 8 percent of GDP, way above the long-run average of 2 percent.

Consumer Caution, Fiscal Tightening

Even after Tuesday's cut, Australian rates are still among the highest in the developed world.

With rates near zero in the United States, Japan and Britain, those countries have taken ever more exotic stimulus steps including buying massive amounts of government debt.

And, as yet, lower rates have had only a limited impact on consumers, with retail sales disappointingly flat in October and demand growth for credit the lowest in decades.

The housing market has also been less than stellar. The Statistics Bureau on Tuesday reported approvals to build new homes slid 7.6 percent in October, so reversing much of September's hefty 9.5 percent increase.

The impact of lower export prices was clear in Australia's trade deficit, which more than doubled in the third quarter. As a result, the current account deficit widened by a fifth to A$14.9 billion ($15.5 billion),according to figures from the Australian Bureau of Statistics.

Fortunately, export volumes managed to outpace imports and so add 0.1 percentage point to economic growth in the quarter.

However, that was more than offset by government penny-pinching as the ruling Labor Party struggles to return the budget to surplus in 2013,years before most other rich nations.

Data out Tuesday showed government spending fell by 2 percent in the third quarter, largely due to a big drop in defense investment.That was a steeper fall than many analysts had expected and could take around half a percentage point from economic growth in the quarter.

It was no surprise then that Treasurer Wayne Swan warmly welcomed the RBA's largesse.

"Today's rate cut is the early Christmas present that hard-working Aussies deserve," he told reporters. "It comes at a time where unemployment is low, and economic growth is in much better shape than many other developed economies."

Figures for gross domestic product (GDP) are due on Wednesday and were expected to show moderate growth of around 0.6 percent in Australia's A$1.4 trillion economy.

Such a result would see growth for the year slow to a still-respectable 3.2 percent, from 3.7 percent. But the balance of risks seems biased to the downside going into 2013.

Analysts estimate that fiscal tightening alone could shave between 0.75 and 1.5 percentage points off GDP growth in the year to end June 2013.