Banks eye rate move despite RBA's halt

RBA governor Glenn Stevens.

Australia's central bank today downgraded its outlook for economic growth and saw much lower inflation, leaving the door ajar for more cuts in interest rates following a surprisingly large 50 basis point easing this week.

“Labor market conditions have continued to be on the soft side to date, with large increases in employment in mining and some service industries roughly offset by declines in the manufacturing, hospitality and retail sectors,” theReserve Bank said today in its quarterly monetary policy statement. “A recovery in housing construction is unlikely in the near term.”

The RBA sees average growth of 3 per cent in 2012, down from its February estimate of 3.5 per cent. Consumer prices will rise 2.5 per cent in the year to December, from a previous prediction of 3 per cent; underlying inflation is predicted at 2.25 per cent from a previous 2.75 per cent, the central bank said.

The estimates are based on the overnight cash rate target remaining at 3.75 per cent, it said.

Today's cuts to the growth outlook by the RBA underscore the challenges facing the Gillard government as it puts its final touches to the federal budget. Treasurer Wayne Swan has pledged to return the budget to surplus in 2012-13, a task made harder by slowing growth and the resulting weaker revenue streams.

The revisions reflect RBA Governor Glenn Stevens's decision three days ago to slash the benchmark rate by half a percentage point to a two-year low, even as most economists polled forecast a quarter-point reduction.

Ahead of today's RBA statement, financial markets viewed the prospect of a further 25 basis-point cut to the cash rate at the central bank's June meeting as a two-in-three chance.

The RBA is trying to buttress a housing market in which prices have fallen for five straight quarters, bolster employment as a high currency hurts non- resource industries and boost confidence that has weakened among consumers who are saving more.

'Subdued growth'

“The assumed high level of the exchange rate and a weak short-term outlook for building construction are expected to result in subdued growth outside of the mining sector in the near term,” the RBA said. “Growth in household spending moderated at the end of 2011 and partial indicators suggest that it remained soft in early 2012.”

Australia's four biggest banks are trying to guard margins against further erosion from elevated wholesale funding costs, by passing through less of the central bank's rate cuts to mortgage holders. The RBA lowered rates twice late last year by 25 basis points.

The RBA said today that its half percentage-point cut this week was made “in order to deliver the appropriate level” of borrowing rates. “The board judged that it was desirable for financial conditions to be easier than those which had prevailed in December, and that this required a 50 basis point reduction in the cash rate.”

The nation's unemployment rate has held at about 5.2 per cent for the past six months, less than half the level in Europe, even as the currency's strength hurts manufacturing and tourism.

Tradables inflation

The central bank, explaining the revision of the inflation outlook, said it expects the decline in the price of international goods to diminish given the exchange rate has been little changed for a year. A weakening in domestically produced inflation will rely on moderate wage growth due to a weaker labor market and improved productivity as companies respond to the heightened competitive pressure caused by the exchange rate, it said.

The central bank described inflation last quarter as “unusually low.”

The economy will also have to absorb the biggest fiscal contraction as a proportion of gross domestic product since the fiscal year that started in July 1953. The government is seeking to return the budget to surplus in the fiscal year beginning July 1. It will deliver the budget May 8.

The RBA noted the plan, saying “public final demand is also expected to grow at well below-trend rates over the forecast period as both federal and state governments undertake fiscal consolidation.”

Weaker exports

Australia's economy is struggling to accelerate, unexpectedly posting back-to-back trade deficits as coal and metal exports slumped. The RBA said today that “exports have been revised lower, largely reflecting a reassessment of the ability of mining companies to utilize new transport and port capacity fully in the near term, along with weaker manufacturing exports.”

The Australian dollar has risen in six of the past seven quarters, and bought $US1.0270 earlier today. Tourism, manufacturing and retail industries have weakened under the currency's 41 per cent rise in the past three years.

Traders are betting there's a 74 per cent chance Stevens will lower rates by a quarter point to 3.5 per cent at the next meeting in June, according to swaps data compiled by Bloomberg.

Resource bonanza

Even after this week's rate cut, Australia has the highest borrowing costs among major developed nations as Stevens seeks to manage an economy powered by demand from emerging nations including China and India for iron ore, coal and natural gas. Chevron, Royal Dutch Shell, Woodside Petroleum and ConocoPhillips are among energy companies spending $180 billion to explore and develop gas fields in Australia.

The RBA said the outlook for mining investment has been revised higher since its last statement as its liaison suggested some projects previously seen as “only possible now look more likely to go ahead than had been previously assumed, and that work on some other projects is progressing at least as fast as was expected.”

The central bank said the biggest offshore risk to its forecast is that Europe's sovereign debt crisis could intensify and derail the upswing in the global economy. Global growth is expected to be 3.5 per cent this year and 4 per cent next year, it said.

“While the likelihood of that occurring has eased somewhat in recent months, partly because of the actions of authorities in Europe, the situation remains fragile,” the central bank said in the statement.

Bloomberg, with Reuters