A Game Changing Interest Rate Cut?

Yesterday’s interest rate cut was just 0.25%, but it could be a market changing fill up needed to stimulate investment this year. This well-written article from the ASX website is reproduced here as it deserves to be widely read.

Australia Cuts Interest Rates — 2nd Update

 By James Glynn

SYDNEY–Australia cut its benchmark interest rate to a record low of 2.25% Tuesday, joining a procession of central banks that have eased policy settings this year in response to the deflationary impact of tumbling oil prices.

The 0.25-percentage-point cut represents a dramatic shift for the Reserve Bank of Australia–which ended 2014 with a message to financial markets that interest-rate stability was likely to feature again in 2015, to help underpin certainty for businesses and support the economy as a mining-investment boom fizzles out.

Gov. Glenn Stevens said the decision to come off the sidelines for the first time in 18 months was driven by concern that Australia’s resource-rich economy was facing another year of below-average growth. The Australian dollar fell sharply on the announcement of a cut, dropping to a fresh 5 1/2 -year low, while the stock market surged to the highest level since May 2008.

Nations cutting interest rates or engaging in stimulus measures are hoping to boost domestic growth and employment by weakening their currencies, making exported goods more competitive overseas. Still, currency depreciation also raises the risk of a tit-for-tat race to the bottom, as trading partners seek to outdo one another only to find gains are limited.

“Financial conditions are very accommodative globally, with long-term borrowing rates for several major sovereigns reaching new all-time lows over recent months,” Mr. Stevens said. The central bank has been cutting rates on and off since late 2011, but has been in a holding pattern since August 2013.

The case for a rate cut was strengthened by recent inflation data, which showed an absence of price pressures in the economy. With falling oil prices also driving lower gasoline prices at the pump, the central bank can safely bet on weak inflation readings for some time.

The Reserve Bank of Australia joins the Monetary Authority of Singapore, Reserve Bank of New Zealand, European Central Bank, Bank of Canada and the central banks of India, Denmark and Switzerland in either announcing substantial policy shifts or easing monetary settings–in some cases dramatically–since Jan. 1.

Throughout last year, Australia’s central bank repeatedly stressed it would be appropriate for rates to remain stable for some time. It removed that reference on Tuesday, leaving open the door to more cuts. “The idea that the RBA could sit there and persist with forward guidance that suggested policy stability was no longer tenable given the action of other central banks so far this year,” said Sally Auld, a fixed-income and foreign-exchange strategist at J.P. Morgan in Sydney.

Financial markets are expecting further rate cuts to follow, factoring in at least one more by June. Mr. Stevens, meanwhile, sought to head off concern about rising house prices, saying that the banking regulator had drawn up plans to stymie any resurgence in speculative mortgage lending. An overheating housing market presents a big risk to the economy since a crash could unravel the Reserve Bank’s limited success in stimulating sectors such as retail and manufacturing.

Australia’s economy, which hasn’t encountered a recession for 23 years, was among the few to emerge from the global financial crisis largely unscathed, thanks to industrializing China’s thirst for the nation’s abundant raw materials. China is Australia’s largest trading partner and the biggest buyer of the country’s top export, iron ore, the steelmaking ingredient for which prices plunged by some 50% last year as supply ballooned.

But China’s recent weakening is also hurting Australia’s economy, which slowed sharply in late 2014 as tumbling commodity prices shook confidence and as critical investment outside the mining industry remained weak despite the record-low interest rates. Unemployment is near its highest levels in a decade, while the sustained fall in oil prices is expected to hit the profitability of vast gas projects across the country’s northern frontier.

Australia’s treasurer, Joe Hockey, said the rate cut would help create jobs, while economists said the “income shock” caused by weaker commodity prices would squeeze government budgets. In Tuesday’s statement, Mr. Stevens said the jobless rate–currently 6.1%–would likely peak a little higher than had been anticipated.

Rob Taylor contributed to this article.

Write to James Glynn at james.glynn@wsj.com


From <http://www.asx.com.au/prices/market-news-detail.htm?an=DJDN000020150203eb23000ly>

Categories: Financial News

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