Bloomberg News

Stevens Splits Market First Time Since Lehman: Australia Credit

August 01, 2011

Aug. 1 (Bloomberg) -- For the first time in three years, Australia’s interest-rate swaps indicate investors are concerned Reserve Bank Governor Glenn Stevens may raise borrowing costs earlier than is needed to curb inflation.

A Credit Suisse Group AG index shows a 15 percent chance the RBA will raise the overnight cash rate to 5 percent from 4.75 percent tomorrow. Another swaps gauge signals the RBA will cut the developed world’s highest benchmark 0.16 percentage point in the next 12 months. The last such split was in July 2008, two months before Lehman Brothers Holdings Inc. collapsed.

The divergence reflects an economy where business and consumer confidence have dropped while annual inflation reached the fastest pace in three years, fueled by a mining boom that helped drive the currency to a record. Australian government bonds, second only to New Zealand among 20 developed markets tracked by Bank of America Merrill Lynch, rallied in July by the most in 11 months, on concerns the economy is faltering.

“Some see the glass as overflowing, some see it rapidly emptying and the retailers claim that they can’t see it at all,” said Sean Keane, an analyst in Auckland at financial advisory group Triple T Consulting and a former head of Asia- Pacific rates trading at Credit Suisse Group AG.

The RBA’s two preferred measures of annual inflation accelerated to 2.7 percent in the second quarter, compared with a gain of about 2.3 percent in the first quarter. The central bank aims to keep underlying inflation in a range of 2 percent to 3 percent on average.

Divided Outlook

Economists are also divided on the outcome of tomorrow’s RBA meeting: One of Australia’s four biggest lenders, Australia & New Zealand Banking Group Ltd., forecast the first rate increase since November, while Westpac Banking Corp. expected Stevens will hold, before cutting rates in December. Twenty-one of 25 economists surveyed July 29 expect the RBA to leave borrowing costs unchanged this month, with the remaining four predicting an increase.

The decision “is a close call,” said Paul Bloxham, Sydney-based chief economist for HSBC Holdings Plc and a former RBA official. “We think rates need to rise but that next week presents significant risks. On balance, we expect the RBA to remain on hold.”

A central bank report last week showed loans provided by Australian banks and finance companies fell in June for the first time since October 2009 as business credit contracted and housing lending grew the least in 27 years.

Slowing Growth

A gauge of Australian manufacturing slumped to a two-year low in July as the currency and the highest borrowing costs in the developed world hurt demand at home and abroad, a report today from PricewaterhouseCoopers and the Australian Industry Group showed. Australian sales of newly built dwellings fell 8.7 percent in June, the biggest drop in five years, the Canberra- based Housing Industry Association said today.

“Amidst the roller coaster of interest-rate sentiment that has unnecessarily become the norm in 2011, the idea that an imminent rate hike is now unavoidable is misplaced,” said Harley Dale, chief economist at HIA.

Traders are betting on a 4 percent chance of a reduction in borrowing costs by year end, December cash-rate futures showed at 5 p.m. today on the Sydney Futures Exchange, down from a 100 percent chance on July 25.

Households are closing their wallets as rising energy bills, falling home prices and global concerns sap confidence. Retail sales unexpectedly dropped in May, the second decline in three months.

‘Boom and Gloom’

“We are currently in the midst of a boom and gloom economy,” Heather Ridout, chief executive officer of the manufacturing group, said today in a statement.

Further clouding the outlook is concern that the U.S. economy has yet to regain the ground it lost during the recession and may be vulnerable to a relapse. Gross domestic product expanded at a 1.3 percent annual rate in the second quarter, after a 0.4 percent pace in the prior period, the worst six months since the recovery began in June 2009, Commerce Department figures showed July 29.

Prospects for the world’s largest economy also were dimmed by wrangling over the nation’s debt burden. President Barack Obama said in Washington on July 31 that leaders of both parties in the U.S. House and Senate had approved an agreement to raise the $14.3 trillion borrowing limit and cut the federal deficit.

Bond Returns

The benchmark 10-year Australian government note’s yield rose to 4.90 percent today from an 11-month low of 4.80 percent on July 29. Australian bonds returned 6.7 percent this year, including reinvested interest, second to New Zealand debt’s 6.8 percent advance, the Bank of America Merrill Lynch indexes show.

Westpac on July 15 became the first among Australia’s four biggest lenders to predict a rate cut in December. The bank, with A$279 billion ($308 billion) in home loans outstanding, said in a statement that “interest rates are too high in Australia given the state of the non-mining sectors of the domestic economy.” It predicted the nation’s unemployment rate may rise as high as 5.75 percent next year from 4.9 percent.

Australia is undergoing what Stevens calls a structural change -- a shift in productive capacity to more mining and construction industries while the stronger currency hurts exporters, education, tourism and manufacturing. Prime Minister Julia Gillard’s government estimates that mining investment will reach A$76 billion this fiscal year.

Energy Projects

Business investment surged 24 percent in the second quarter, led by liquefied natural gas projects, Deloitte Access Economics said in a July 28 report. Projects valued at A$357 billion were committed or in progress as of June 30, up A$70 billion from the previous three months.

The same day, ConocoPhillips, the third-largest U.S. oil company, and partner Origin Energy Ltd. approved the first stage of a $20 billion LNG project in Australia.

The Australian dollar climbed to $1.1081 after the July 27 inflation report, the strongest level since exchange controls were scrapped in 1983. The Aussie, the world’s fifth-most traded currency, advanced 2.5 percent last month and traded at $1.1054 at 5 p.m. today in Sydney.

The day after the consumer prices index report, ANZ became the first of the nation’s four largest lenders to predict an increase in rates tomorrow.

Inflation has reached “an uncomfortably high starting point given the robust 2012 outlook,” ANZ chief economist Warren Hogan wrote in a July 28 report.

Rate Outlook

“A small upward adjustment to interest rates now could well save the Australian economy from a painful series of rate hikes in 2012,” he said.

Inflation expectations, which had been declining on concern European and U.S. debt crises will roil global markets, gained after last week’s consumer price data. The gap between yields on 10-year inflation-linked bonds and debt not indexed to consumer prices widened 17 basis points over the past week to 2.92 percentage points today. The gap represents the average annual inflation rate anticipated by investors over the bonds’ lifetime.

--With assistance from Daniel Petrie in Sydney. Editors: Garfield Reynolds, Brendan Murray

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net


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