Bloomberg News

Record RBA Rates Pause Seen in Best Bond Rally: Australia Credit

October 02, 2011

Oct. 3 (Bloomberg) -- Australian central bank Governor Glenn Stevens may keep interest rates unchanged until July, a record stretch, economists said as speculation of a global recession spurs the nation’s bonds to lead a worldwide rally.

Stevens will hold the overnight cash-rate target at a developed-world high of 4.75 percent tomorrow and leave it there until the middle of next year, the median of 22 economists’ estimates showed. Yields on government notes from one to 12 years in maturity fell below the Reserve Bank’s benchmark last quarter as they rallied 9.9 percent over the past 12 months, the steepest gains among 26 markets tracked by Bloomberg.

The RBA, which last raised rates in November, is balancing inflation driven by resources investment and a stronger currency that’s hurt manufacturing jobs and damaged confidence. Stevens has opted not to respond to Australia’s fastest annual inflation in three years as Europe’s intensifying debt crisis roiled financial markets and pushed global equities to the biggest drop since 2008.

“For the RBA to remain on hold for more than two years would be very unusual, but I would argue the circumstances are very unusual right now,” said Stephen Walters, JPMorgan Chase & Co.’s chief economist in Australia, who last week dropped his forecast for two rate increases in 2012. The currency’s recent decline has “done some of the loosening for the RBA and that will have taken some pressure off,” he said.

Dollar, Yields Slide

The so-called Aussie dollar, the world’s fifth-most traded currency, has dropped 13 percent from its record-high $1.1081 reached July 27 amid speculation Greece will default and spur a repeat of the 2008 credit freeze that followed the collapse of Lehman Brothers Holdings Inc. The Australian currency slid 1.2 percent last week to 96.62 U.S. cents and was at 96.74 at 10:48 a.m. in Sydney today.

Ten-year Australian government bond yields fell 15 basis points in September to 4.22 percent, completing the longest stretch of monthly declines since at least 1978. Money-market rates also dropped last quarter, with cash-rate futures signaling in August the RBA would lower rates as much as 125 basis points by year end.

The tension between the economic stimulus from record mining investment and the global disruptions spurred by U.S. and European fiscal crises have left economists split between bulls and bears with regard to RBA rates.

Forecasts in the Bloomberg survey for the key rate’s level on June 30, 2012, ranged from 4 percent to 5.25 percent, with five expecting at least one reduction, seven seeing rates unchanged and 10 predicting an increase in borrowing costs.

‘Pessimistic’ View

RBA Deputy Governor Ric Battellino signaled last month that market pricing showing traders betting on rate cuts by the central bank was “pessimistic.” December cash-rate futures yielded 4.12 percent today, up from a 2011 low of 3.47 percent on Aug. 9. The RBA had considered raising borrowing costs in August after a July 27 report showed annual inflation accelerated to 3.6 percent in the second quarter.

“The elevated level of inflation will keep the RBA from cutting rates,” said Paul Bloxham, chief economist for HSBC Holdings Plc in Sydney. “We have not seen enough weakness in the global or local economy, as yet, to see the RBA revising down its forecasts such that inflation heads to the lower part of the target band.” The central bank aims to keep inflation within a 2 percent to 3 percent range on average.

Consumer Prices

Consumer prices rose 2.8 percent last month from a year earlier following a 2.9 percent annual gain in August, according to an index compiled by TD Securities Inc. and the Melbourne Institute released in Sydney today.

The manufacturing index dropped to 42.3, the lowest level since June 2009, from 43.3 in August, the Australian Industry Group and PricewaterhouseCoopers said in a survey released today. It was the sixth month in seven the index was below 50, the dividing line between expansion and contraction.

The RBA in August extended the current rates pause to 10 months, the longest stretch without a move since a 13-month hiatus that ended in May 2006, four months before Stevens took office as governor. The central bank held borrowing costs from December 1994 to July 1996 in the longest period without a move since policy makers began targeting inflation with monetary policy in January 1990.

The RBA boosted its rate seven times from October 2009 to November 2010, tempering a rise in consumer debt, which more than tripled in the past 20 years to 153.7 percent of disposable income in the second quarter. Investors predict at least 1.25 percentage points of cuts over the next 12 months, according to a Credit Suisse Group AG index based on swaps trading.

Contracts for the RBA’s October, November and December rate meetings recovered in recent weeks as central bank officials repeatedly said it is “too early” to judge what the global turmoil means for the domestic economy and that market pricing is due to “technical factors.”

Global Risks

“The technical factors largely refer to the increased interest in using Australia as a market to hedge global risks,” said Bloxham, a former central bank official.

The October future yielded 4.71 percent today in Sydney, compared with 4.53 percent a month earlier.

“Australia is seemingly a good candidate for global money managers to place trades that assume that if the world does see a significant downturn, the RBA will cut rates aggressively,” Bloxham said. “There are few other countries, if any, with deep, liquid, high-quality paper, where interest rates are high enough to believe that the central bank can respond with significant moves.”

Stevens slashed rates from 7.25 percent to a 49-year low of 3 percent from September 2008 to April 2009 as the collapse of Lehman Brothers started a global financial crisis.

Banking System

Since then, the Australian banking system has increased capital levels, cut its reliance on short-term wholesale funding and made greater use of deposits as a source of funding, the RBA said in its financial stability review on Sept. 23. Even so, credit growth has slowed to the weakest since 1977 and house prices are weakening.

“With house prices softening, borrowers cannot sell their property as easily if they get into payment difficulty, meaning fewer cases of arrears are likely to be resolved by the sale of the property than when prices were rising,” the central bank said in the half-yearly report.

Loans provided by Australian banks and finance companies remain subdued, increasing 0.2 percent in August from the previous month, the central bank said in a report last week.

The nation’s jobs market has also weakened, with monthly employment growth averaging 2,800 from January through August, less than a 10th of the average of 30,500 in the first eight months of 2010. Australia’s unemployment in August rose for a second straight month, reaching a 10-month high of 5.3 percent.

Swaps Markets

The Markit iTraxx Australia index of credit-default swaps on corporate debt surged 104 basis points since June 30 to 217 on Sept. 30, outpacing a 95 basis-point climb to 201 for the Markit iTraxx Europe, CMA prices show. The Markit CDX North America Investment Grade Index climbed 52 basis points to 144.

The extra yield investors demand to hold Australian corporate debt instead of government notes widened to 241 basis points on Sept. 30, the highest in two years, from 177 on June 30, Bank of America Merrill Lynch indexes show.

Myer Holdings Ltd., Australia’s biggest department-store chain, sees consumer confidence at a three-decade low and doesn’t expect any improvement in at least six months, Chief Executive Officer Bernie Brookes said in an interview last week.

Elevated U.S. unemployment, Europe’s failure to contain the debt crisis and slowing Chinese demand for commodities may contribute to a less robust rebound in Australia’s economy next year. The International Monetary Fund last month lowered its forecast for the nation’s increase in gross domestic product in 2012 to 3.3 percent, from 3.5 percent in early August.

Flood Rebound

Australia’s economy contracted 0.9 percent in the first quarter this year from the prior quarter, according to government figures. GDP rose 1.2 percent in the second quarter, the most in four years, as growth returned after flooding in the nation’s northeast.

Driving Australia’s economy is demand from developing nations including China and India for iron ore, coal and natural gas. That has spurred the nation’s currency to a 38 percent gain since Dec. 31, 2008, the most among more than 150 currencies Bloomberg tracks against the U.S. dollar.

Battellino, the RBA’s top official after Stevens, said last month the economy should extend its two-decade expansion.

“It is too early at this stage to judge with any degree of certainty whether Australia will catch cold from the U.S.,” Battellino said in a Sept. 21 speech in New York. “However, given that over the past 10 to 15 years the Australian economy has been less vulnerable to severe U.S. symptoms, there are reasonable grounds for optimism.”

--With assistance from Daniel Petrie and Sarah McDonald 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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