Australia Entering Aggressive Rate Cutting Cycle: Pros

The Reserve Bank of Australia (RBA) is widely expected to lower interest rates by 25 basis points to 3.50 percent at its next meeting Tuesday, however, slowing housing and retail sectors could push the central bank into a more aggressive rate cutting cycle with the market expecting up to 165 basis points in cuts over the year.

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“We think rates could come down by 100 basis points over the next few months… Australia’s rates are too high (and) the domestic economy is clearly in need of further stimulus,” Bill Evans, Global Head of Economics, Westpac told CNBC Asia’s “Squawk Box” on Monday.

Evans, who believes the RBA could surprise with a 50 basis point rate cut on Tuesday, says, “The housing market, which is the most interest rate sensitive part of the economy and is very important for jobs and the economy, is in desperate need of some support.”

In May, housing prices fell 1.4 percent across all capital cities to a six-year low, with Melbourne the worst performing city, according to data published by research firm RP Data.

Retail sales, which make up around 20 percent of gross domestic product (GDP), are also losing momentum, declining for the first time in 10 months in April against a consensus forecast of a modest rise.

Greg Bundy, Vice Chairman & Senior Adviser at AIMS Finance agrees that the widely expected rate cut will be the start of further monetary policy easing.

“I’d like to see 50 basis points (of rate cuts tomorrow) but the reality is that we’ll probably see a 25 bas point cut, it will be a series of cuts here. The Reserve Bank has done a wonderful job during the global financial crisis and it’s probably the only central bank in the world that has room to maneuver in terms of the G-10,” Bundy said.

A private gauge of inflation released on Monday showed price pressures remained well contained last month, supporting views that interest rates will be cut this week. The RBA last cut interest rates in May by a larger-than-expected 50 basis points.

While the market is betting the RBA will cut rates by 165 basis points over the course of this year says Hamish Pepper, Currency Strategist at Barclays Capital, he does not think the central bank will go beyond the expected 25 basis points cut on Tuesday.

According to Pepper, commodity prices and exports have not fallen to worrying levels as yet for the central bank to cut rates sharply.

“Australian commodity prices have declined 15 percent since highs of August of last year. If we go back to the global financial crisis, commodity prices fell 40 percent,” Pepper said.

“Also, we haven’t seen a decline in exports that we saw during the global financial crisis. Trade financing, which stopped following the crisis, is still available. Exports are still robust,” he added.

Most Overvalued Currency?

Rate cuts will help in weakening the Australian dollar , which has fallen over 5 percent against the U.S. dollar in the past month, but is still seen by some as overvalued.

According to Bundy of AIMS Finance, it is the “most overvalued” currency among G-10 nations driven by the country's high interest rate environment. However, he adds that as interest rates come down the currency will further weaken.

“A little bit over 60 days ago the currency at 1.08, today at 96, can it fall further? Yes I think it can. If it breaches 95 next stop, 90,” he added.

Since the global financial crisis, the Aussie has been regarded as one of the mostattractive carry trades by investors, as the RBA was the first G-20 central bank to lift rates in October 2009, however forex strategists believe this trade could be at risk.

John Noonan, Senior FX Analyst at Thomson Reuters who is also bearish on the Aussie dollar due to headwinds in the global economy, forecasts the currency could hit 93.80 against the U.S. dollar this week.