RBA Holds Rates

Australia left interest rates unchanged Tuesday as a declining currency cushions the impact of lower commodity prices and a weaker outlook for key trading partner China. Reserve Bank of Australia Governor Glenn Stevens and his board kept the cash rate at a record-low 2 percent, as predicted by markets and economists following reductions in May and February. The currency has dropped more than 2 U.S. cents since the last meeting.

“Most of the available information suggests that moderate expansion in the economy continues,” Stevens said of Australia in his statement. “Equity markets have been considerably more volatile of late, associated with developments in China,” referring to the stock rout in that country.

Stevens altered his language on expectations for the Federal Reserve’s first rate increase to “the period ahead” from last month’s “later this year.” The U.S. tightening is expected to exert further downward pressure on the Australian dollar.

The weaker Aussie is “having an increasingly supportive impact on sectors like education and domestic tourism,” said Justin Tyler, an investment manager at Aberdeen Asset Management Ltd. in Sydney. “However, the RBA remains aware of the risks posed by potential weakness on the part of our major trading partners, particularly China.”

Investment Cut

The currency was slightly weaker after the RBA decision and was trading at 71.28 U.S. cents at 3:05 p.m. in Sydney.

Australia has so far had little success in stimulating industries with rate cuts as a decade-long mining investment boom unwinds. Businesses plan to cut investment by 23 percent this fiscal year as firms decide they can meet demand from heavily indebted households with existing capacity.

Crazy Sydney

One area where cheap borrowing costs have worked is the property market: prices in Sydney have soared and Stevens has described parts of the market as “crazy.” The governor noted today that prices “continue to rise strongly” in the nation’s biggest city. Sydney housing rose 1.1 percent in August and are up 17.6 percent from a year earlier.

Traders are pricing in a 50-50 chance of another rate cut by November as Australia, the developed world’s most China-dependent economy, struggles to cope with slumping prices for key resource exports.

China devalued its currency Aug. 11, and a day later reported industrial production, investment and retail data that trailed analysts’ estimates. After China’s stock market recorded the steepest falls since 1996, policy makers Aug. 25 cut benchmark lending and saving rates for the fifth time since November 2014 and lowered banks’ required reserve ratio by half a percentage point.

Factory Gauge

Data today showed China’s official factory gauge fell to the lowest reading in three years as monetary easing failed to revive growth.

“The global economy is expanding at a moderate pace, with some further softening in conditions in China and east Asia of late, but stronger U.S. growth,” Stevens said today. “Key commodity prices are much lower than a year ago, in part reflecting increased supply, including from Australia. Australia’s terms of trade are falling.”

Yet Australia’s labor market has remained relatively resilient, aided by weaker wages growth, with unemployment at 6.3 percent in July as more people entered the workforce.

Similar to the U.S., debate is intensifying Down Under on whether potential growth is lower than earlier thought, which would help explain the stabilizing labor market. A reduced speed limit from the RBA would ease pressure to cut rates. Economists predicted Australia’s economy expanded 2.2 percent in the second quarter from a year earlier ahead of data due Wednesday.

“Growth rates have mostly started with a ‘2’ for a while now – despite the lowest interest rates in our lifetimes,” Stevens said in remarks last week. “It may be about changing demographics. It may be that potential growth is a bit lower than we used to think — though I don’t think we can know whether that is so at present.”

(Source: Bloomberg)