Australia Signals First Rate Reduction in Seven Years

By Jacob Greber

Aug. 5 (Bloomberg) -- Australia's central bank signaled it may cut borrowing costs for the first time in almost seven years as slowing economic growth cools inflation.

``With demand slowing, the board's view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing,'' Governor Glenn Stevens said today in Sydney after keeping the overnight cash rate target at 7.25 percent. He has raised the rate four times in the past 12 months.

The Australian dollar fell to a three-month low after traders bet Stevens, 50, will cut rates as soon as next month as the economy slows, forcing companies including Qantas Airways Ltd. and Starbucks Corp. to fire workers. Retail sales, consumer confidence and house prices have all fallen since the Reserve Bank last raised the benchmark in March.

``They've gone from neutral and moved to a very clear easing bias,'' said Su-Lin Ong, senior economist at RBC Capital Markets Ltd. in Sydney. ``There is a real acknowledgement that financial conditions are too tight.''

The Australian dollar dropped to 92.22 U.S. cents at 4:32 p.m. from 92.72 immediately before today's decision. The two- year government bond yield fell 22 basis points to 5.97 percent. A basis point is 0.01 percentage point.

The currency has fallen almost 6 percent against the U.S. dollar since hitting a 25-year-high 98.49 U.S. cents on July 16.

Bank Stocks

Stevens could join other central bankers around the world who have cut borrowing costs to cushion their economies from slower growth. New Zealand cut its key rate last month for the first time in five years. Australia's benchmark is 5.25 percentage points higher than the Federal Reserve's rate.

Australia's benchmark S&P/ASX 200 Index pared losses as Commonwealth Bank of Australia Ltd., the nation's biggest mortgage lender, led a rally by banks after Stevens' announcement. The index was 1.4 percent lower at the 4:10 p.m. close in Sydney, recovering from a 2.6 percent slump, its weakest level in 2 1/2 years.

``The Reserve Bank is pretty much indicating it's ready to cut rates, and banks are the first to turn when it looks like stimulation is coming,'' said Prasad Patkar, who helps manage $1.8 billion at Platypus Asset Management in Sydney.

The Reserve Bank has raised the benchmark rate 12 times since its last cut in December 2001 to curb inflation that has accelerated to 4.5 percent. It aims to keep annual price gains between 2 percent and 3 percent on average.

Inflation Outlook

Stevens said today the bank expects inflation will slow to below 3 percent during 2010.

``It is looking more likely that demand will remain subdued and economic growth will be fairly slow over the period ahead,'' he said.

Australia's $1 trillion economy, in its 17th year of growth, expanded at the slowest quarterly pace in almost two years in the three months through March.

Since the central bank's previous meeting on July 1, reports have shown consumer confidence slumped in July to the lowest level in 16 years, retail sales fell 1 percent in June, and lending to consumers and businesses rose at the slowest annual pace since 2002. House prices fell in the second quarter for the first time in almost three years.

Qantas, Australia's largest airline, said last month it will fire 1,500 workers. Starbucks, the world's largest chain of coffee shops, said July 29 it will close three-quarters of its 84 Australian stores, part of a plan to cut 12,000 jobs globally.

Unemployment Rises

The jobless rate, which fell to a 34-year low of 3.9 percent in February, probably rose to 4.3 percent last month from 4.2 percent in June, according to the median estimate of 24 economists surveyed by Bloomberg. The government will publish the jobs report on Aug. 7.

Investors have increased bets the central bank will cut borrowing costs, according to a Credit Suisse Group index based on trading in interest-rate swaps.

Stevens will lower the benchmark rate by 91 basis points, or 0.91 percentage point, in the next 12 months, the index showed at 4:31 p.m. in Sydney. At the start of July, traders forecast 19 basis points of gains.

Stevens may also cut the rate in to unwind the impact of higher mortgage costs on households.

The nation's five largest lenders, including Commonwealth Bank, have added an average 105 basis points to mortgage rates in 2008 as the global credit squeeze drove up funding costs. The central bank has added a total of 50 basis points in that time.

The increases have added A$250 ($231) to monthly payments on an average A$250,000 home loan, according to the Real Estate Institute. Households spent 38 percent of their incomes on mortgage payments in the March quarter, the most in the 22 years that the institute has measured affordability.

``The tightening in financial conditions, in conjunction with other factors, including rising fuel costs, and lower asset values, has restrained demand,'' Stevens said.

Today's decision was forecast by all 24 economists surveyed by Bloomberg News.

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