Bloomberg News

RBA Christmas Rate Cut Signaled by Debt Market: Australia Credit

November 02, 2011

Nov. 2 (Bloomberg) -- Australia’s debt market shows investors expect Reserve Bank Governor Glenn Stevens to follow his first rate cut in 2 1/2 years by lowering borrowing costs next month to spur spending in the Christmas holiday season.

The implied yield on December interbank cash rate futures was 4.26 percent, indicating traders expect the RBA to lower borrowing costs at its Dec. 6 meeting. Australia’s bonds rallied after Stevens reduced the overnight cash-rate target to 4.5 percent yesterday. Three-year bond yields tumbled 10 basis points, or 0.1 percentage point, to 3.66 percent at 5:25 a.m. in Sydney, or 328 basis points more than similar Treasuries.

Stevens joined policy makers across the Asia-Pacific region in lowering interest rates as Europe’s debt crisis dims prospects for the world economy and after Australia’s core inflation rate dropped to the weakest in 14 years. The RBA retains the developed world’s highest benchmark borrowing costs as exports to China and India and a A$430 billion ($444 billion) pipeline of resource projects drive growth.

“The next cut will come in February after the bank gets further evidence on inflation and has time to assess the impact of this move,” said Bill Evans, chief economist at Sydney-based Westpac Banking Corp. who in July was the first to predict a reduction this year. The chance of a December cut “certainly cannot be fully dismissed but is not our central view,” said Evans, who forecast the rate will be 3.75 percent by the end of next year.

‘Welcome Relief’

Australian Prime Minister Julia Gillard said yesterday’s decision brought “welcome relief” to households. Commonwealth Bank of Australia, the nation’s biggest lender, and Westpac cut variable mortgage rates by the same amount as the central bank’s reduction. Westpac said the lower borrowing costs announced yesterday would save customers A$41 monthly on a A$250,000 mortgage.

Across Asia, trade “is starting to see some effects of a significant slowing in economic activity in Europe, where the prospects are for economic weakness to continue,” Stevens said in the statement after yesterday’s decision.

Stocks tumbled worldwide as concerns increased that Europe can’t contain its debt crisis and manufacturing slowed in the U.S. and China. The MSCI Asia-Pacific Index slid 0.8 percent, heading for its first three-day decline since Oct. 5.

Greek Prime Minister George Papandreou’s grip on power weakened after his call for a referendum to approve a bailout for his country provoked lawmaker defections from his party and fueled concern a default would undermine financial stability across Europe.

‘Major Gamble’

Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. in Newport Beach, California, called the call for a referendum a “major political gamble,” that puts the European Union, International Monetary Fund and European Central Bank in a tough position.

Manufacturing in the U.S. was close to stagnating in October, the Institute for Supply Management’s factory index showed yesterday, amid cooling global demand. A Chinese factory index dropped to the lowest level since February 2009, while a U.K. manufacturing gauge declined to a 28-month low, separate releases yesterday showed.

China is Australia’s biggest trading partner and its demand for iron ore, coal and energy has driven the South Pacific nation’s terms of trade, or export prices relative to import prices, to a record.

‘Global Meltdown’

“The market will always flirt, particularly in Australia’s case, with the thought of a global meltdown,” said Jarrod Kerr, director of Australia rates strategy at Credit Suisse Group AG in Singapore. “Australia is obviously highly correlated to global growth and Asia so if we do see a significant downturn then that will be felt here and the RBA will do more than what us economists are thinking.”

The 10-year rate dropped 15 basis points to 4.25 percent today, compared with a yield of 2.04 percent for similar U.S. Treasuries.

Stevens cut the cash rate from 7.25 percent to 3 percent from September 2008 to April 2009 to counter a global credit freeze after Lehman Brothers Holdings Inc. collapsed.

Twenty-two of 24 economists surveyed by Bloomberg News after yesterday’s decision predicted the central bank will keep rates unchanged next month. Economists at Goldman Sachs Group Inc. and BNP Paribas SA forecast a quarter percentage point cut.

Eleven of 24 analysts forecast a reduction in the first quarter next year, the survey showed. The rate may be 4 percent in February and 3.75 percent by April, cash rate futures show.

Subdued Conditions

Stevens, in his statement after reducing rates yesterday, said “subdued demand conditions and the high exchange rate have contained inflation.”

An Australian government report last week showed annual underlying inflation in the three months ended Sept. 30 averaged about 2.5 percent, the mid-point of the central bank’s 2 percent to 3 percent target range.

The gap between yields on Australian five-year inflation- linked debt and benchmark notes of similar maturity was 2.35 percentage points, the lowest level since September 2010. The spread indicates investor expectations for consumer-price gains over the lifetime of the debt.

The Markit iTraxx Australia index of credit-default swaps that gauges perceptions of corporate bond risk surged 12 basis points to 186 as of 4:51 p.m. in Sydney, according to National Australia Bank.

Corporate Debt

The extra yield investors demanded to hold Australian- dollar corporate bonds instead of government debt declined to 245 basis points yesterday, after reaching 253 on Oct. 27, the highest since August 2009, a Bank of America Merrill Lynch index shows.

Australia’s rising exports to China and India, two countries that account for more than a third of the world’s 7 billion people, helped spur the local currency to $1.1081 on July 27, the highest since it was freely floated in 1983.

Europe’s fiscal troubles have weighed on the so-called Aussie in recent months. The world’s fifth most-traded currency fell 10 percent last quarter on concern Greece would default and trigger a repeat of the 2008 credit freeze after the collapse of Lehman Brothers.

The Australian dollar rose 0.7 percent to $1.0397.

EU leaders agreed on Oct. 27 to increase a bailout fund to 1 trillion euros ($1.4 trillion), recapitalize banks and write down Greek debt by 50 percent.

The difference between Australian two- and 10-year bond yields slipped to 43 basis points, the least since Aug. 1.

“The market is pricing some chance of the end of the world,” said David Plank, head of research at Deutsche Bank AG in Sydney. “While the risks around Europe remain high, which I suspect will be the case for a very long time, the market will have a bias to pricing a more aggressive easing cycle than is likely in the central case.”

--With assistance from Daniel Petrie and Sarah McDonald in Sydney. Editors: Garfield Reynolds, Benjamin Purvis

To contact the reporters on this story: Michael Heath in Sydney at mheath1@bloomberg.net; Candice Zachariahs in Sydney at czachariahs2@bloomberg.net

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


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