Markets Are Betting On A Rate Reduction in Australia

Australia was betting on a low CPI today. You would think it was crazy to hope for poor economic data ‎but in the case of Australia, consumers and businesses are hoping and praying for a rate cut by the RBA ‎this month. Markets should know that they can never pre-guess Glenn Stevens.‎

The trimmed mean CPI, a measure of underlying inflation, rose by 0.3 per cent in the quarter and by ‎‎2.2 per cent in the year to March.‎ That puts the pace of underlying price increases in the bottom half of the Reserve Bank’s target for ‎inflation of between two per cent and 3 per cent, and clears the way for a cut in the Reserve’s cash ‎rate when it next meets, on May 1.‎

The Reserve signaled that it was ready to ease rates if inflation remained under control when it left the ‎cash rate unchanged at 4.25 per cent at its last meeting on April 3. It said then that pace of growth was ‎‎”somewhat lower than earlier estimated,” but that it believed that it would be ”prudent to see ‎forthcoming key data on prices to reassess its outlook for inflation, before considering a further step ‎to ease monetary policy”.‎

That data is now in, in the form of today’s quarterly CPI. It’s low enough to create room for a cut of a ‎quarter of a percentage point on May 1, and probably lays for the groundwork for another cut after ‎that.‎ Cuts are overdue: the Reserve has been holding rates high to contain demand and price inflation in the ‎resources boom, but the boom has slowed in the last six months as commodity prices have eased, and ‎impact of the Reserve’s high rates on areas of the economy that are not plugged directly into the ‎boom has been severe.‎The central bank now has the room it has said it needed to hand sectors including tourism and ‎manufacturing relief – relief that will come not from a reduction on borrowing costs that will flow from ‎a cut in the cash rate, but from reduced pressure on the Australian dollar, which is driven to an extent ‎by the strength of interest rates on offer to international investors, and by the stimulus to demand in ‎the economy generally that a rate cut will deliver.‎

An official rate cut next week seems all but a certainty after official inflation data showed prices barely ‎budged in the March quarter.‎ Consumer prices inched up a less than expected 0.1 per cent in the first quarter, following a flat ‎reading in the previous three months.‎ For the year to March 2012, prices increased by 1.6 per cent, following a 3.1 per cent increase over ‎‎2011, the Australian Bureau of Statistics said today. The market had expected a 0.6 per cent rise in the ‎quarter and a 2.2 per cent rise in the year.‎

The core inflation measure, which is watched closely by the Reserve Bank in setting policy, was 2.15 ‎per cent in the year to March, down from 2.6 per cent. For the March quarter it was 0.35 per cent, ‎down from 0.5 per cent.‎ The Aussie dollar fell from $US1.031 to $US1.026 immediately after the data was released, as markets ‎bet on more than one official rate cut.‎ Investors are now pricing in a 100 per cent chance of a 25 basis point cut in May, and a one-in-four ‎chance of a 50 basis point cut. Before the inflation update, the market was tipping only a 93 per cent ‎chance of a rate reduction next month.‎

And with inflation seemingly contained for some time to come, investors were willing to lend the ‎government money for 10 years at just 3.67 per cent. That is the lowest 10-year bond yield since the ‎early 1950s.‎


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