Australia May Cut Rates by Most Since 2001, Traders' Bets Show

By Jacob Greber

Sept. 26 (Bloomberg) -- Traders almost doubled bets that the Reserve Bank of Australia will cut the benchmark interest rate by 50 basis points for the first time in seven years, to encourage banks to boost lending amid a global credit freeze.

The odds of a 50-point cut next month were at 53 percent at 2:40 p.m. in Sydney, up from 32 percent on Sept. 22 and zero on Sept. 12, according to a Credit Suisse Group index based on trading in interest-rate swaps. Three-month interbank loan interest rates today exceeded the cost of six-month bills by the most since April 2001, showing investors expect rates to fall.

``The pressure in the short-term money market really does suggest that even if the Reserve Bank cuts by 25 basis points, banks wouldn't pass that on,'' said Brian Redican, a senior economist at Macquarie Group Ltd. in Sydney. ``Policy makers will have to cut by 50 basis points'' to get banks to trim mortgage rates.

Banks are hoarding cash, pushing up funding costs to the most since Bear Stearns Cos. collapsed in March, as talks falter on the U.S. government's $700 billion plan to rescue the financial system. Mike Smith, the head of Australia & New Zealand Banking Group Ltd., signaled yesterday the nation's fourth-largest bank may not pass to mortgage customers all of any potential central bank rate cuts when policy makers meet on Oct. 7.

Australian lenders increased deposits with the central bank five-fold in two weeks to a record A$7.4 billion ($6.2 billion) as they seek risk-free investments. The cash is in exchange settlement accounts at the Reserve Bank, which earn interest at 25 basis points below the central bank's 7 percent benchmark rate. A basis point is 0.01 percentage point.

Central bank Governor Glenn Stevens reduced the overnight cash rate target by a quarter-percentage point this month from a 12-year high.

Funding Costs

Three-month bank bill yields were 19 basis points higher than six-month yields today, the most since April 2, 2001, two days before the Reserve Bank last cut benchmark rates by half a point. The central bank reduced borrowing costs in 2001 as global growth slumped following the collapse of internet stocks. Interest rates are usually higher the longer the term of the lending.

``Market participants want more aggressive rate cuts by the RBA,'' said Akira Takei, general manager for international bonds at Mizuho Asset Management Co. in Tokyo. ``Global banks are being more and more stingy with credit and small companies are having trouble raising financing.''

Australian policy makers said they cut borrowing costs on Sept. 2 because the risk of leaving the benchmark rate too high for too long outweighed the danger of stoking inflation, according to minutes of the decision.

Consumer Spending

Consumers reduced quarterly spending in the three months through June for the first time since 1993, slowing gross domestic product growth to the weakest pace in more than three years.

``One school of thought argues that only a 50 basis point cut will get market interest rates down sufficiently,'' said Stephen Walters, chief economist JPMorgan Chase & Co. in Sydney. ``Our view, though, is that a combination of political and political pressure should be sufficient to trigger material falls in market interest rates'' following a quarter point reduction by the central bank, he added.

Speculation of a larger cut by the Reserve Bank increased as U.S. Congress debates U.S. Treasury Secretary Henry Paulson's plan to inject $700 billion into paralyzed credit markets.

Hoarding Cash

``The bottom line is that banks continue to hoard cash and liquidity remains tight,'' said Joshua Williamson, a senior strategist at TD Securities Ltd. in Sydney. ``An improvement in the short-term is now very dependent on the speedy passing and implementation of the U.S. government's rescue package.''

The difference between the rate that banks charge each other for three-month loans and the overnight indexed swap rate stood at 93 basis points in Sydney, after widening to as much as 99 points yesterday, Bloomberg data show. The gap, a benchmark for bank funding, averaged 17 basis points last year.

``It's in nobody's interests to keep rates high,'' ANZ Chief Executive Officer Smith said in Sydney yesterday when asked whether his bank will pass on in full any Reserve Bank rate cuts next month. ``I want to reduce rates as well. However, I have to fund a book. We will have to wait and see,'' he said.

Australian lenders cut the rate on variable mortgages, used by about 90 percent of the nation's households, by 25 basis points following the Reserve Bank's decision to lower the overnight cash rate by that amount on Sept. 2.

``There will be an economic cost from the credit crisis,'' said Macquarie's Redican. ``Global growth will be slower and that will flow through to Australia. That, as well as the increase in funding costs, means there is much more scope for the Reserve Bank to be more aggressive'' in cutting rates.

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