Australia Cuts Rates as the Economy Runs out of Mining Steam

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on Oct 2, 2012

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Australia Cuts Rates as the Economy Runs out of Mining Steam

On 2 October 2012, the Reserve Bank of Australia (RBA) announced that it was lowering its benchmark interest rate amid fears that the country’s resources boom was running out of steam more quickly than expected, as reported by the Financial Times. Among the reasons quoted for the RBA’s decision are also the contracting economic activity in Europe and the slowing growth in China, one of Australia’s largest export markets.

The RBA lowered its cash rate by 25 basis points to 3.25 percent, as noted in a statement by the central bank’s governor Glenn Stevens. The decision is an attempt to revive demand outside the mining sector, which has been one of the key drivers of the Australian economy. “Looking ahead, the peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected,” noted Mr Stevens. “As this peak approaches it will be important that the forecast strengthening in some other components of demand starts to occur.” The FT quotes analysts at Deutsche Bank as seeing the rate cut as insufficient for strengthening the “other components” of demand. “We suspect today’s 25 basis points cut will not be enough in the face of a significant negative terms of trade shock and an exchange rate, that in our view, is likely to remain elevated,” the analysts noted.

!m[](/uploads/story/503/thumbs/pic1_inline.png)Bloomberg reports that Governor Stevens reversed his outlook after saying in a speech in June that he felt the need to do some “cheerleading” on the economy to refute pessimists. Mr Stevens, however, now notes that in recent months weaker growth has been observed both at home and abroad, with key commodity prices for Australia remaining significantly lower than earlier in the year.

While the RBA move was unexpected, it follows the global September trend set by the US Federal Reserve and the European Central Bank (ECB) which have tried to boost confidence in markets by announcing open-ended programmes for asset purchasing. China’s central bank, which refrained from implementing rate cuts in June and July, is expected to launch stimulus measures after the Communist party congress in the beginning of November.

The FT reports that the slowdown in China in particular has hit Australian commodity prices, with iron ore, Australia’s most valuable export, falling by more than one-third since July. Thermal coal, which is another important Australian export, is close to reaching a two-year low. Bloomberg notes that while Australia’s economy grew approximately by four percent in the first half of 2012 on account of resource-industry investment and consumer spending, weaker commodity prices and elevated currency prompted mining companies such as BHP Billiton Ltd (ASX:BHP, NYSE:BHP) and Fortescue Metals Group Ltd. (ASX:FMG, PINK:FSUGY) to put off projects and cut off jobs in the past two months.

“Growth in China has also slowed, and uncertainty about near-term prospects is greater than it was some months ago. Around Asia generally, growth is being dampened by the more moderate Chinese expansion and the weakness in Europe,” noted Governor Stevens in central bank’s statement.
The RBA announcement quickly resonated in the markets, with the Australian dollar immediately dropping by more than half a cent to US$1.031, whereas the main Australian stock market index increased by one percent to 4433.7 points, according to FT data.