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Australia holds key rate as house-price risk outweighs inflation

Tuesday, November 1, 2016 - 12:27

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Reserve Bank of Australia Governor Philip Lowe kept interest rates unchanged, signaling he's prepared to tolerate weak inflation to avoid further escalating property prices and household debt.

[SYDNEY] Reserve Bank of Australia Governor Philip Lowe kept interest rates unchanged, signaling he's prepared to tolerate weak inflation to avoid further escalating property prices and household debt.

Lowe opted not to react to soft consumer prices growth last quarter and held the cash rate at a record-low 1.5 per cent, as predicted by 22 of 28 economists surveyed and in line with money market bets. The new governor's well-flagged concerns about easy money's risks to financial stability has led traders to scale back bets on a reduction next year as well.

"A key reason for the RBA's reluctance to cut rates further is the strength in the housing market," Felicity Emmett, head of Australian economics at Australia & New Zealand Banking Group Ltd, said before the decision. Soaring Sydney and Melbourne prices and "already historically high household gearing counts strongly against the RBA acting on its easing bias." The governor's confidence in letting inflation languish well below target stems from stronger economic growth and lower unemployment, as well as a rebound in commodities and an improved outlook in key trading partner China; Lowe has already said that he and his colleagues aren't "inflation nutters." The decision also fits into a growing global consensus among central bankers that monetary policy is approaching the limits of its effectiveness.

The RBA may also get some relief from the local dollar, the best performing Group of 10 currency since June 30, if the US Federal Reserve raises rates in December. A depreciating Aussie would provide a tailwind to services exports like tourism and education that are highly sensitive to the currency and key growth drivers for the post-mining boom economy.

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Given his signals on financial stability, Lowe would be loathe to further inflate Sydney house prices - already up more than 50 per cent in the past four years - or increase household debt that's soared to a record 158 per cent.  That's particularly so when the economy expanded an annual 3.3 per cent in the second quarter, even though much of that came from labor-light resource exports. The jobless rate has fallen to 5.6 per cent, though that level is also flattered by a falling participation rate and high part-time employment.  Then there's commodities: the terms of trade, or export prices relative to imports, are rising for the first time in more than two years. Coking coal has surged more than 200 per cent this year as output from China, the world's biggest miner, tumbles under government pressure to cut overcapacity. Iron ore, Australia's biggest export, has rebounded almost 50 percent.

Australia's core annual inflation averaged 1.5 per cent in the third quarter, well below the central bank's 2 per cent to 3 per cent target range. Record-low wage growth, imported disinflation, fierce local retail competition and spare capacity in the economy all suggest consumer prices are unlikely to rebound soon; as a result, many economists view the RBA as retaining an easing bias.

Still, prior to the decision traders were pricing in less than one-in-two chance of a rate cut next year.

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