Bloomberg News

Linkers Show GDP Boom Fails to Spur Inflation: Australia Credit

December 07, 2011

Dec. 8 (Bloomberg) -- Investors expect Australian inflation will slow, allowing the Reserve Bank to keep cutting interest rates even as the economy expands at the fastest pace in four years, government bond yields indicate.

The gap between rates on five-year government notes and inflation-linked debt show traders expect a 2.29 percent annual rise in consumer prices through 2016, at the lower end of the RBA target. Gross domestic product grew 1 percent last quarter and a revised 1.4 percent three months earlier, government data showed yesterday, the fastest six-month gain since March 2007.

Benchmark 10-year yields dropped 27 basis points since Sept. 30 to 3.95 percent, set for the longest run of quarterly declines since 1998 following Asia’s financial crisis as concerns mount that Europe’s debt crisis will damage global trade. Australian bonds are the second-best developed-world performers this year, Bloomberg data show. A pipeline of resource projects has cushioned a slump in services and manufacturing hit by the Aussie dollar’s climb to a record.

“The high currency and a small increase in unemployment may mean modest fourth-quarter inflation and that would give the RBA room to cut rates further,” said Peter Jolly, head of market research at National Australia Bank Ltd. “While there are large risks to growth ahead, the economy has been quite strong and growth will continue to recover into the New Year provided Europe’s issues don’t become aggravated.”

Rate Bets

Traders are betting the central bank will cut rates by at least one percentage point within 12 months, the largest expected declines across the developed world, Credit Suisse Group AG indexes show.

Yesterday’s data showed the only Group of 10 economy to avoid a recession during the global credit crisis was well placed before Europe’s financial turmoil intensified.

Finance Minister Penny Wong said the GDP report reflects “a very good economic story for Australia,” in a Bloomberg News interview. Private business investment is driving growth and incomes are rising in the context of low unemployment “and inflation that’s contained,” she said yesterday.

Australia’s government announced A$6.8 billion ($7 billion) in spending reductions last week as part of its mid-year review to meet a pledge to return the budget to surplus by 2013. Yesterday’s data showed government spending dropped 1.2 percent, subtracting 0.2 percentage point from growth.

The GDP figures “confirm that the economy is probably just slightly stronger than what we anticipated,” Wong said.

Stevens Eases

Reserve Bank Governor Glenn Stevens lowered rates this week in the first consecutive cuts since 2009 to boost demand after consumer confidence deteriorated this half with purchasing manager surveys indicating manufacturing, construction and services are contracting.

Investors pared bets for a 50-basis-point cut at the next policy meeting Feb. 7, interbank futures showed yesterday. The contracts still indicate a better than 50 percent chance the central bank will drop its benchmark to 3 percent, matching the lowest since 1960, by June.

The RBA, which considered raising rates as recently as August to head off inflation, said Dec. 6 that consumer-price growth will likely remain within the bank’s target range of 2 percent to 3 percent in 2012 and 2013.

The five-year breakeven rate dropped to 2.18 percentage points last month, the lowest level since at least 2009, after reaching a peak of 3.14 in May. Annual inflation was 3.5 percent in the third quarter, slowing from 3.6 percent, the government reported in October.

Inflation-Linked Debt

Australian inflation-linked notes returned 17.5 percent to investors this year, including reinvested interest, heading for the best annual performance in data stretching back to 1997, Bank of America Merrill Lynch data show. The securities have climbed the most across 18 markets tracked by the Merrill Lynch indexes.

Rising exports and A$456 billion of planned mining and energy projects helped spur the local currency to $1.1081 on July 27, the strongest since it was freely floated in 1983.

Europe’s troubles have weighed on the so-called Aussie in recent months. The world’s fifth most-traded currency has fallen 7.3 percent since its peak on concern Greece would default and trigger a repeat of the 2008 credit freeze after the collapse of Lehman Brothers Holdings Inc.

Germany and France risk losing their AAA credit ratings in a review of 15 euro nations, Standard & Poor’s said Dec. 5 as the region struggles to lower budget deficits with unemployment near 10 percent.

Multi-Speed Economy

Yesterday’s report showed Australia’s economy expanded 2.5 percent in the third quarter from a year earlier, faster than the 1.9 percent increase predicted by economists.

China is Australia’s biggest trading partner and its demand for iron ore, coal and energy drove the nation’s terms of trade -- a measure of export prices relative to import prices -- to a record this year. Mining increased 3.7 percent, adding 0.3 percentage point, yesterday’s report showed.

The report highlighted what the RBA has called a multi- speed economy, with the resource-rich states of Western Australia and Queensland leading growth while the two most- populous regions -- New South Wales and Victoria, contributed almost nothing to last quarter’s expansion.

Western Australia’s economy expanded 8.4 percent last quarter from three months prior and Queensland grew 3.5 percent. New South Wales increased 0.5 percent while output in Victoria shrank 0.1 percent, yesterday’s data showed.

Bond Rally

Government bonds in Australia returned 13.2 percent this year, including reinvested interest, behind only the U.K. among 26 markets tracked by the Bloomberg/EFFAS indexes. Australian sovereign debt is heading for its biggest gains since 2008.

The premium investors demand to hold Australian corporate bonds instead of government debt increased 35 basis points over the past month to 282 on Dec. 6, and touched the widest since July 2009 at 286 last week, Bank of America Merrill Lynch indexes show.

Australia’s jobless rate was 5.2 percent in October, after matching a more-than-two-year low of 4.9 percent in March and April. Government data today may show unemployment stayed at that level in November, with the number of workers increasing by 10,000, according to the median estimate of 24 economists surveyed by Bloomberg.

“The first RBA interest-rate decision of the New Year should extend the period of rate cuts,” said Paul Brennan, a senior economist at Citigroup in Sydney. “Further insuring the economic expansion against downside risks from Europe now that partial domestic indicators for the fourth quarter are showing some moderation is the path of least regret, particularly as early calculations suggest inflation will be extremely soft in the fourth quarter.”

--Editors: Garfield Reynolds, Brendan Murray

To contact the reporters on this story: Michael Heath in Sydney at; Candice Zachariahs in Sydney at

To contact the editor responsible for this story: Stephanie Phang at

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