Australia Central Bank Says Room to Cut Interest Rate

By Jacob Greber

Aug. 11 (Bloomberg) -- Australia's central bank says it will have more room to cut interest rates because of a ``significant moderation'' in domestic demand that will cut economic growth by half and drive up unemployment.

``Economic growth will be fairly slow in the period ahead,'' the Reserve Bank of Australia said in its quarterly policy statement released in Sydney today. Gross domestic product will probably expand 2 percent this year compared with 4.3 percent in 2007 and less than the 2.25 percent forecast by the bank in May.

Borrowing costs at a 12-year high, surging gasoline prices and a slump in consumer confidence are forcing households to cut spending, helping ease inflation pressures, the bank said. Governor Glenn Stevens left the benchmark lending rate at 7.25 percent last week and signaled he may cut it for the first time since 2001.

``On the assumption that the subdued demand conditions are likely to continue, scope to move to a less restrictive monetary policy stance in the period ahead is increasing,'' today's statement said. The bank expects a ``significant reduction in inflation over time.''

The Australian dollar dropped to 88.59 U.S. cents at 11:33 a.m. in Sydney from 88.72 cents before the statement was released. The two-year government bond yield fell 2 basis points, or 0.02 percentage point, to 5.92 percent.

The currency has declined more than 10 percent against its U.S. counterpart since reaching a 25-year high of 98.49 cents on July 16 on speculation the Reserve Bank will cut borrowing costs as soon as next month.

Inflation Forecasts

Inflation is forecast by the bank to peak at 5 percent in the fourth quarter, compared with the 4.5 percent predicted in the May statement, before slowing to 2.75 percent in 2010.

The bank aims to keep annual gains in consumer prices between 2 percent and 3 percent on average. They rose 4.5 percent in the second quarter.

``Demand pressures in the economy now appear to be easing and the forecasts project a significant period of slower growth, which will result in a moderation of capacity pressures,'' today's statement said.

Still, the bank said there are risks to its inflation forecasts ``in both directions.''

While the figures for the June quarter, released last month, suggested ``quite tentative'' evidence that inflation pressures may no longer be rising, income from Australia's trade boom could stimulate domestic spending and leave ``inflation expectations entrenched at unacceptably high levels,'' the statement said.

Resources Boom

Demand for coal and iron ore from China has boosted Australia's terms of trade, a measure of export income, by 20 percent this year, taking the increase in the past five years to 65 percent, the bank said. ``The income gains from this source continue to represent a significant stimulus to the economy.''

Policy makers raised the benchmark interest rate in March, February, November and last August amid concern the lowest unemployment in more than three decades would drive up wages and inflation.

Stevens and his board will cut the overnight cash rate target by at least 25 basis points to 7 percent when they meet on Sept. 2, according to 18 of 25 economists surveyed by Bloomberg News last week. Of those, five predict a 50 basis point reduction and seven expect no change.

Since the bank's last quarterly statement on May 9, there have been increasing signs the nation's $1 trillion economy is slowing.

Consumer confidence slumped in July to the weakest level in 16 years and home-loan approvals tumbled in June to a four-year low.

Slower Growth

The economy will probably grow 2.5 percent in 2009 and 2.75 percent in 2010, today's statement predicts. It expanded 0.6 percent in the first quarter, the slowest quarterly pace in almost two years. Second-quarter gross domestic product figures will be released on Sept. 3.

The bank also said ``any further deterioration in the outlook for global growth would present a significant downside risk'' to its Australian GDP forecasts, ``particularly if it led to a marked slowing in growth in China and India.''

``In addition, the ongoing turmoil in capital markets could exacerbate the slowing in domestic growth by further reducing the availability of credit to households and businesses,'' it said.

The Reserve Bank said investment in residential property is ``expected to contract over the next year'' because of the cost and availability of credit, as well as ``the subdued state of the housing market.''

House prices fell in the second quarter for the first time in almost three years.

Demand for labor will continue to ease, the bank said. Australia's jobless rate was 4.3 percent in July, up from 3.9 percent in February, which was the lowest since 1974.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net