Growing Risks Of Further Rate Cuts
BMI View: The Reserve Bank of Australia (RBA) lowered its cash rate to 2.75% from 3.00% in its latest monetary policy meeting. Although the central bank hopes to support demand through easier monetary conditions, we maintain our view that the deteriorating employment outlook, fuelled by a downbeat business outlook is likely to discourage households from spending. Moreover, given that we believe that real GDP growth will slow sharply to 2.1% compared to the RBA's estimates of 3.0%, we see growing risks that the central bank could adopt a more aggressive stance and cut rates beyond our forecast of 2.50% by the end of the year.
The Reserve Bank of Australia (RBA) cut its policy interest rate by another 25 basis points (bps) in its latest monetary policy meeting, bringing the rate to an all-time low of 2.75% from 3.00%. While we maintain our expectations for the central bank to cut rates by another 25 bps by end-2013, we see that there are growing risks that the central bank will adopt a more aggressive and proactive stance to monetary easing as we believe that real GDP will slow to 2.1% in 2013 from 3.6% in 2012.
|Lower Interest Rates To Provide Little Boost|
|Australia - Housing-Related Credit, % of GDP & % chg y-o-y (RHS)|
Rate Cuts To Prove Insufficient To Boost Households Spending
In line with our expectations for the domestic activity to slow, the economy has begun to show signs of weakness, with retail sales and new car sales in March both declining and missing most observers' estimates. These signs suggest that households are becoming more cautious as they cut back on large expenditure items and discretionary spending, converging with the downbeat outlook of businesses, where we have seen firms reduce their capital expenditures and roll back their hiring plans. Indeed, we believe that the reduced optimism of households has prompted the RBA to cut rates in a bid to reduce rising debt burdens which may have hindered consumption. However, this is unlikely to happen given the lack of improvement in the business outlook, which we believe will lead to further deterioration in the job market and the unemployment rate to rise to 6.0% by the end of 2013 from the 5.5% recorded in March.
We believe that this souring employment outlook will weigh on households' consumption plans, outweighing the attempts by Australian banks to reignite mortgage lending by passing on the reduction in interest rates. Moreover, as we have cautioned previously (see, Tough Times Ahead, What Can Replace The Mining Boom?, May 3) , the shaky fundamentals, of a growing number of investors who are negatively-geared and homes in negative equity, suggest that house prices are unlikely to be sustained at current levels. Indeed, we believe that this plays well into our bearish Australian financials (over the broader index) view, as banking profits are likely to decline as households pay down their debts and as losses on bad debt increase as the unemployment rate rises.
|How Low Will Rates Go?|
|Australia - RBA Cash Rate, %|
Weaker-Than-Expected Economy Could Prompt Even Deeper Cuts
Given that we believe that subsequent economic data from Australia is likely to disappoint, we maintain our outlook for another 25bps cut by end-2013. However, the central bank appears to be increasingly keen, in its latest monetary statement, to undertake further easing should the economy weaken further. Moreover, given that we expect Australia's real GDP to come in much weaker than the RBA's base scenario forecast of 3.0% (our forecast stands at 2.1%), we see growing risks that the RBA could take rates below our forecasted 2.50%. This strengthens our conviction on our bullish Australian 10-Year government bonds over its New Zealand counterpart, and we see room for further upside on this view.