Bloomberg News

Stevens Rate Cut Bets Smallest in Two Months: Australia Credit

October 10, 2011

Oct. 10 (Bloomberg) -- European efforts to avert a banking crisis are reducing expectations for lower interest rates in Australia, bond market measures show.

Reserve Bank of Australia Governor Glenn Stevens suggested less than a week ago he’s willing to lower the developed world’s highest benchmark rate of 4.75 percent as Greece’s struggle to avoid default damps investor confidence and growth. As markets rallied last week after the European Central Bank said it will give banks access to unlimited cash, bond investors pared bets the RBA will repeat the series of cuts that followed Lehman Brothers Holdings Inc.’s collapse in 2008.

“The market has now got it into its head that there’s going to be some sort of solution,” Matthew Johnson, a strategist at UBS AG in Sydney, said in a telephone interview on Oct. 7. “There are some serious headwinds playing out there, so I don’t really see the market moving away from pricing in rate cuts because the RBA is now talking about it as well.”

The implied yield on the December cash-rate future closed on Oct. 7 at 4.17 percent, the highest since Aug. 4, signaling a cut of 58 basis points, or 0.58 percentage point, down from wagers for more than 125 basis points of reductions on Aug. 9. The future’s implied yield declined to 4.155 percent as of 2:42 p.m. in Sydney. Over the next 12 months, the RBA will lower its key rate by 140 basis points, a Credit Suisse AG index based on swaps showed, compared with 161 on Oct. 4.

Capital Injections

Yields on benchmark 10-year bonds rose for a fourth- straight day, gaining five basis points to 4.29 percent. The rate is 221 basis points more than U.S. Treasuries of similar maturity. Australian 10-year yields fell 15 basis points in September, completing nine-straight monthly declines for the longest such stretch since at least 1978, Bloomberg data show.

Yields on all Australian benchmark government bonds due until 2023 have been less than the RBA’s key rate since Aug. 9.

The ECB said Oct. 6 it would reintroduce purchases of covered bonds and yearlong loans for banks to support markets rattled by the region’s sovereign debt crisis. The Bank of England boosted its asset-purchase program by more than a third to 275 billion pounds ($428 billion) in a bid to avert a recession in the U.K.

Dexia Plan

Underscoring the urgency, the board of Dexia SA met yesterday to begin dismantling the French-Belgian lender. Dexia’s breakup, three months after it got a clean bill of health in European Union stress tests, brought the region’s banking crisis from the continent’s periphery to its center.

“The RBA’s central case is not a disruptive financial crisis,” Johnson said. “If that occurs they’ll do emergency monetary policy like every central bank.”

European Union leaders are under pressure from investors to rescue the region’s banks before a Group of 20 summit in November.

“By the end of the month, we will have responded to the crisis issue and to the vision issue,” French president Nicolas Sarkozy said in Berlin yesterday at a joint briefing with the German chancellor Angela Merkel before they dined at her office.

Under rising pressure to defuse turmoil that’s raged for 18 months, and facing growing concern Greece is headed to a default, Merkel said European leaders will do “everything necessary” to ensure that banks have enough capital.

Aussie Rallies

Last week’s moves bolstered investor confidence, spurring rallies in global markets. The Australian dollar, the world’s fifth-most traded currency, rose 0.5 percent to 98.18 U.S. cents in recent trading, extending a 1.1 percent climb in the five days ended Oct. 7 that was its first weekly gain in a month.

The Aussie has appreciated 40 percent since Dec. 31, 2008, the most among more than 150 currencies Bloomberg tracks against the U.S. dollar.

“There are clearly risks, but there’s no hard evidence to suggest the Australian economy has felt anything in real terms from developments in Europe,” Gavin Stacey, chief interest-rate strategist at Barclays Capital in Sydney, said in a telephone interview Oct. 7.

Australia’s economy will expand 1.8 percent this year, accelerating to 3.3 percent in 2012, International Monetary Fund staff said in a report Oct. 7, reiterating forecasts made last month. Bolstered by Asian demand for commodities, the outlook “remains favorable, despite global financial market volatility in recent months,” it said.

RBA Forecasts

Stevens cut the cash rate from 7.25 percent to 3 percent between September 2008 and April 2009 to counter a global credit freeze. The RBA then lifted the cash rate by 175 basis points after credit markets started thawing in 2009, giving Stevens scope to lower borrowing costs if Europe’s crisis threatens the global economic recovery.

“It will take more time for evidence of any effects of the recent European and U.S. financial turbulence on economic activity in other regions to emerge,” Stevens said Oct. 4 after leaving the benchmark unchanged for an 11th straight month. “An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.”

Three of 21 economists surveyed by Bloomberg News predict the RBA will lower rates to 4.5 percent at the next policy meeting on Nov. 1. Eighteen expect no change. Goldman Sachs Group Inc. cut its 2012 growth forecast for Australia to 3 percent from 3.8 percent on Oct. 4, saying expansion in China and the Asia-Pacific region would be curtailed by Europe and a weakening economy in the U.S.

Fitch Downgrades

Fitch Ratings downgraded Italy and Spain Oct. 7 on concern they will struggle to improve their finances, while Moody’s Investors Service put Belgium on review for a possible cut.

“It appears the European governments are kicking the Greek can down the road up until the point that they’ve been able to ring fence Italy and Spain and also ring fence the banks,” Barclays’ Stacey said.

Australia’s economy is being driven by a mining boom and record prices of exports relative to import costs spurred by China’s demand for commodities including iron ore and coal.

The nation’s exports surged to a record A$28.4 billion ($27.9 billion) in August on coal shipments, and the A$3.1 billion trade surplus was the second-widest on record, the Bureau of Statistics said Oct. 4. Retail sales rose more than economists forecast for a second-straight month in August, data the following day showed.

Credit-Default Swaps

The gap between yields on Australian government bonds and inflation-indexed notes shows investors estimate consumer prices will rise an average of 2.43 percent for the next five years, down from 2011’s peak of 3.14 percent on May 6.

Australian corporate bond risk reached the highest since May 2009 last week, credit-default swaps show.

The Markit iTraxx Australia index closed at 215.6 basis points on Oct. 7 after surging as high as 239 on Oct. 4, CMA data show. The average cost of insuring senior debt of the four biggest banks rose as high as 243, from a low this year of 99 on March 9, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The extra yield investors demand to hold Australian dollar- denominated corporate bonds instead of similar-maturity government debt rose to 249 as of Oct. 6, the highest since August 2009, Bank of America Merrill Lynch index data show. Average spreads fell one basis point to 248 on Oct. 7, according to the index.

“Credit investor sentiment is fragile and the outlook for Australian companies is definitely getting weaker, with slower growth and lower profits ahead,” Nick Bishop, a portfolio manager in Sydney at Aberdeen Asset Management Plc, said in a telephone interview on Oct. 7. “On top of that, the systemic European bank risk fears add an element of hysteria to spreads. There is no road map for what Europe is grappling with.”

--Editors: Garfield Reynolds, Benjamin Purvis

To contact the reporter on this story: Sarah McDonald in Sydney at smcdonald23@bloomberg.net. Candice Zachariahs in Sydney at czachariahs2@bloomberg.net

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net. Rocky Swift at rswift5@bloomberg.net


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