Bloomberg News

Bond Market Doubt Grows on RBA’s Steady Rates: Australia Credit

September 04, 2011

Sept. 5 (Bloomberg) -- The rally in Australian government bonds, the developed world’s best performers this year, shows investors disagree with the central bank’s view that resource investment will support growth and avert interest-rate cuts.

Government securities from one month to 12 years in maturity yield less than the Reserve Bank’s 4.75 percent overnight cash rate target even after Governor Glenn Stevens said Aug. 26 inflation remains “concerning.” The RBA will keep the highest benchmark among advanced economies unchanged tomorrow, said all 25 economists surveyed by Bloomberg News.

Stevens’s confidence he doesn’t need to lower rates is underpinned by a projected A$225 million ($238 million) a day in mining investment and record prices for commodities exported by the only developed economy to avoid 2009’s global recession. Investors concerned Europe’s debt crisis will stall the global recovery are betting the RBA will cut borrowing costs by the most among the Group of 10 currencies in the coming year.

“From the central bank’s point of view, you have inflation heading towards the top of your band and one of the largest mining investment booms in history coming through,” said Jarrod Kerr, director of Australia rates strategy at Credit Suisse Group AG in Singapore. “It’s very hard to cut rates in that environment and probably irresponsible to do so unless there is some very severe trigger.”

Treasury Spread

Ten-year government bond yields dropped 16 basis points today to 4.25 percent 1:01 p.m. in Sydney, after falling for an eighth month in August to complete the longest stretch of declines since 1991. The yield is 226 basis points, or 2.26 percentage points, more than for similar-dated U.S. Treasuries.

The rate on the 10-year U.S. note tumbled 14 basis points on Sept. 2 to 1.99 percent as the payrolls report showed no jobs were added in August, stoking speculation that the Federal Reserve will increase its purchases of longer- maturity debt.

Australian sovereign debt delivered a 9.2 percent return this year, the best among 21 developed nations tracked by Bloomberg and the European Federation of Financial Analyst Societies.

In Aug. 26 testimony to a parliamentary committee, Stevens said the RBA has sufficient “ammunition” with rates to respond to a sudden downturn in the global economy, an outcome he said he isn’t anticipating. Australian companies and consumers are better positioned to withstand market volatility than they were three years ago, he said.

The RBA raised its benchmark by 1.75 percentage points from October 2009 to November 2010 to control consumer-price gains. The world’s most aggressive round of rate increases as the global economy emerged from the financial crisis spurred the local dollar’s 25 percent gain over the past two years, hurting exporters.

Rate Outlook

Goldman Sachs Group Inc. and Deutsche Bank AG predicted the RBA will lower rates this year after an Aug. 11 report showed the jobless rate rose in July for the first time since October.

Cash-rate futures showed an 18 percent probability Stevens will cut rates tomorrow, compared with a 100 percent chance of a reduction as recently as Aug. 12. The RBA may lower its benchmark by 125 basis points within a year, a Credit Suisse index based on swaps trading shows.

Australian companies have been looking past reports showing weaker U.S. and European growth, spending more on plant and equipment to meet surging demand from emerging markets in Asia that were the main drivers of the world’s economic recovery over the past two years.

Mining investment is projected at A$82.1 billion in the 12 months to June 30, 45 percent higher than in the 2010-2011 fiscal year, a government report showed last week.

Profit Surge

A government report today showed business profits advanced last quarter by more than double economists’ estimates as mining and utility companies benefited from stronger prices. Gross operating profits rose 6.7 percent from the previous three months, while inventories swelled the most in eight years.

Australia’s investment pipeline helped boost the local dollar, the world’s fifth-most traded currency, to $1.1081 on July 27, the strongest since it was freely floated in 1983. The so-called Aussie recently traded at $1.0596.

Gross domestic product grew 1 percent last quarter, a separate economists survey showed before a Sept. 7 government report, as output rebounded from a contraction in the previous three months spurred by flooded coal mines and farmland.

Weaker Confidence

Consumer confidence in Australia has weakened in recent months on signs that parts of the economy are buckling under the pressure of currency appreciation and the developed world’s highest borrowing costs. Corporate bond sales have dried up as the premium investors demand to hold such debt rather than government securities climbed to the most in 2 1/2 years.

The spread widened 39 basis points in August, the biggest jump since March 2009, and was at 222 basis points on Sept. 2, Bank of America Merrill Lynch indexes show.

Australian unemployment unexpectedly jumped to an eight- month high of 5.1 percent in July as hiring stalled. The 41,400 net job gain from January through July was the weakest first seven months of the year since 2003.

Job advertisements fell 0.6 percent in August, an Australia & New Zealand Banking Group Ltd. report today showed, matching the decrease in July.

Manufacturing Slump

Manufacturing has slumped to its weakest in more than two years, a private report showed last week. BlueScope Steel Ltd. last month said it will cut about 1,000 jobs because of a second-half loss due to high raw-material costs and the local dollar’s surge against its U.S. counterpart.

“While many will jump to the conclusion that even a modest rise in the unemployment rate would be enough to see RBA cuts, we think that a modest rise is exactly what is required to get some of the inflation out of the system and keep unit labor costs under control,” said Paul Bloxham, chief economist for HSBC Holdings Plc in Sydney and a former RBA official. “To see a direction change by the RBA we think you would need a decisive rise in the unemployment rate.”

Bond investors are estimating Australian consumer prices will rise at an annual 2.55 percent pace over the coming five years, according to the gap between indexed government debt and bonds that aren’t linked to inflation.

Monthly Inflation

Inflation declined in August for the first time since October 2009, led by cheaper fruit and vegetables, according to a private report today. Consumer prices slid 0.1 percent last month after a 0.3 percent increase in July, according to an index compiled by TD Securities Inc. and the Melbourne Institute released in Sydney. Prices rose 2.9 percent from a year earlier following a 3.2 percent gain in July.

The central bank aims to keep inflation in a 2 percent to 3 percent range on average.

Since Stevens held the overnight cash rate target unchanged for an eighth straight meeting on Aug. 2, investor confidence has slumped after Standard & Poor’s cut the U.S.’s credit rating and as Europe’s sovereign-debt crisis deepened.

“If we did see a very dramatic change for the worse in the global economy, certainly we have plenty of interest rates to play with if need be,” Stevens told lawmakers last month. “In terms of macroeconomic ammunition, there would be not that many countries who could say they had more than us in the event of a really big episode. I don’t think that’s occurring at the moment.”

Unemployment Concern

Concern that unemployment will rise as global growth falters are among reasons economists at Westpac Banking Corp., Goldman Sachs, Deutsche Bank and Bank of America Corp.’s investment banking unit predict reductions in borrowing costs this year.

Policy makers in Brazil, second to Australia among the world’s biggest exporters of iron ore, last week cut rates by 50 basis points, citing a “substantial deterioration” in the global economy.

Stevens, responding to Australian lawmakers last month, said unemployment hovering near 5 percent is “a low number.”

“When I started at the Reserve Bank, the notion that you could have 5-ish percent unemployment and 2-ish or 3-ish inflation, was a dream,” he said.

Australia’s services industry expanded in August for the first time in four months, led by growth in finance, communication and recreation even as a strong currency damped demand in other areas.

The performance of services index climbed 3.3 points to 52.1, the highest level since April 2010, Commonwealth Bank of Australia and the Australian Industry Group said in Sydney today. A figure above 50 indicates expansion.

--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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