Pressure builds for Australia to cut its interest rates

THE AUSTRALIAN dollar’s climb to within 5 cents of a record, driven by demand from as many as 23 national central banks, is piling pressure on the Reserve Bank of Australia (RBA) to cut the developed world’s highest interest rates.

The so-called Aussie reached $1.0625 last Friday, the strongest since March, and is trading about 30c higher than its average since exchange controls were scrapped in 1983. Brazil, Russia and Germany are among 15 countries that hold the currency, while eight possible buyers include Iceland and Jordan, according to RBA data obtained on Monday by Bloomberg News under the Freedom of Information Act.

The inflows helped fuel a 2.2 percent gain in the currency against nine developed nation peers in the past year, the most after the British pound, Bloomberg correlation-weighted indices show. That prompted calls from the Treasury, business executives and union leaders that RBA interest rate cuts may be needed to lower the Aussie. The nation sold A$58 billion (R499bn) of government bonds to foreigners in the year to June, overtaking coal as its second-biggest export, according to Pacific Investment Management.

“If commodity prices and the Australian dollar remain at current levels, we think the Australian economy will require policy support,” said Adam Bowe, a Sydney-based portfolio manager at Pimco, the largest bond investor. “With the federal government undertaking a significant fiscal consolidation, any required policy response is more likely to come from the RBA in the form of lower interest rates.”

Treasurer Wayne Swan has pledged to cut spending in the current fiscal year to return the budget to surplus.

The Australian dollar, which reached a post-float high of $1.1081 in July 2011, has gained versus 13 of its 16 most-traded counterparts in the past 12 months, hurting industries from tourism to manufacturing and education by reducing their capacity to compete against overseas rivals. It is close to its closing price on October 31, the day before the RBA started cuts that lowered the key rate 1.25 percentage points in the space of seven months. At 5pm in Johannesburg yesterday, the Australian dollar was bid at $1.0466 (R8.6394).

“The apparent preference shift and resulting portfolio shift of foreign investors towards Australian dollar government securities has increased Australian dollar demand,” Chris Potter of the RBA’s international department wrote in an April 5 document that was among those released on Monday by the central bank. “The increase in demand associated with this shift appears large by historical standards.”

Demand from abroad for Australian government bonds helped drive yields on all the securities to record lows in June. Benchmark 10-year rates touched 2.698 percent on June 1 after foreign holdings of federal securities maturing in one year or more reached a record 79 percent in the first quarter of 2012.

‘The sustained high level of the Australian dollar is crushing the competitiveness of Australia’s export manufacturers.’

The central bank referred to Potter as a junior officer and said his paper was a draft that shouldn’t be seen as representing the RBA’s views. Even so, in parliamentary testimony on August 24, RBA governor Glenn Stevens echoed Potter’s assessment.

The increased demand for Australian government debt may have helped drive down the perceived risk of trading the currency because investors such as central banks are less likely to suddenly sell their assets, Potter wrote.

The dollar’s strength has led manufacturers including Caltex Australia and Ford Motor to cut jobs. “The sustained high level of the Australian dollar is crushing the competitiveness of Australia’s export manufacturers,” Paul Howes, the national secretary of the Australian Workers Union, said in an e-mailed response to questions. “We strongly believe that the Reserve Bank needs to consider the relationship between interest rates and the exchange rate when making decisions on monetary policy.”

Master Builders Australia said in an e-mailed statement on September 12 that further RBA cuts “are needed to turn consumer pessimism around and ensure that demand recovers”.

Reports this month showed retail sales dropped in July by the most since 2010, while second-quarter gross domestic product growth was slower than economists estimated. The number of people employed in Australia fell last month by 8 800, the statistics bureau said on September 6.

The figure compares with forecasts for an increase by 5 000.

Prices for Australian raw materials exports plunged 19 percent in local dollar terms in the 12 months to August, reaching the lowest levels since April 2010, RBA data showed this month.

BHP Billiton said last week it would stop production at a second coking coal mine in Australia’s Queensland state.

The company last month delayed the Olympic Dam copper-uranium-gold project in South Australia, estimated at $33bn, joining companies including Fortescue Metals, Xstrata and Rio Tinto in scaling back expansions.

If the local dollar rose high enough to start hurting the economy, this would be reflected in increased spare capacity and, ultimately, declining inflation, the Australian Treasury said in an August 17 report. “In these circumstances we could expect that monetary policy would be eased, putting downward pressure on the exchange rate,” the department said.

Minutes of the RBA’s September 4 meeting released on Tuesday showed officials saw the strength of the local currency and slowing growth in China as risks to the domestic economy, signaling scope to cut interest rates if necessary. China is Australia’s biggest trading partner.

Australia & New Zealand Banking Group said policymakers would probably reduce the RBA’s overnight cash rate target by 25 basis points at both their October and November meetings, according to an e-mailed note to clients on Tuesday. It is the first of Australia’s four largest lenders to predict an October cut. The bank’s previous forecast was for reductions of 25 basis points in November and in the first quarter of 2013, with unchanged rates thereafter and a bias to lower rates. The RBA’s key rate currently stands at 3.5 percent.

Interest rate swaps data show traders see the cash rate dropping more than 50 basis points by February and more than 75 basis points by April.

“The market is pricing RBA cuts over the next 12 months, which seems justified given the implications for Australia’s terms of trade from recent falls in commodity prices,” Pimco’s Bowe said on Monday, in reference to the windfall from exports.

The Federal Reserve’s decision last week to buy $40bn a month of mortgage bonds to bolster the US economy spurred rallies in higher-yielding assets worldwide. The Aussie surged 1.6 percent last week, its strongest gain since June, while the MSCI world index of shares advanced to the highest level since July last year.

The extra yield investors demand to hold Australian dollar corporate notes instead of sovereign debt was at 205 basis points on Monday, the least since August 2011, Bank of America Merrill Lynch data show.

The Markit iTraxx Australia index of credit default swaps that gauges perceptions of corporate bond risk was littlechanged at 137.665 basis points on Tuesday, according to Markit Group. It posted the lowest close since March 21 on Monday, according to CMA.

The demand for riskier assets drove down Australia’s government bonds. The 10-year yield was at 3.37 percent at 12pm on Tuesday in Sydney. It jumped 15 basis points to 3.43 percent on Monday, offering 172 basis points more than the average among its peers rated AAA by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.

The Aussie has gained 2.6 percent versus the greenback this year even as prices for iron ore, the top commodity export, slumped 24 percent. “If the effect of the Fed’s easing is to widen the disconnect between the value of Australian dollar and where commodity prices suggest it should be, that increases the chances the RBA will lower interest rates,” Ray Attrill at National Australia Bank in Sydney said. – Bloomberg RISING tide lifts all boats, goes the saying, but nobody ever talks about what happens when the tide sinks again. This has been left for the EU to teach us. When the going is good it pays to be tied to your neighbours. Your strengths become their strengths and their excess becomes your earnings.

But when the tables turn and you are in need of an escape, their demands become your noose. This is the story unfolding in the EU and instead of the open free-market paradise that was envisaged, the situation has become one of slave and slave driver.

To join the euro zone, member states ceded the right to print their own currency to the European Central Bank, adopted the common currency of the euro and gave up control of their own monetary policy.

Before this, countries were able to control the money supply within their own borders. By reprinting more or less of their currency or by expanding or contracting the level of commercial loans or bond issues they were able to change the quantity and value of their currency. This also allowed them to control the value of their debts.

If a country found itself in the position of owing large payments on internal or external bonds, such as the current situation in Spain and Greece, for example, they had the facility to increase their money supply, and pay back their debts in nominal terms.

The consequence of this would be a decrease in the real value of their currency, rising inflation, and perhaps mistrust of the government or higher borrowing costs in the future as in real terms they paid back less than they owed.

Done in excess these actions could ruin an economy. But managed moderately they could certainly leave the country, and its creditors, in a better position than what many European countries on the brink of default find themselves in now.

By subscribing to EU monetary policies individual members have given up the reins to manage their own economies and the control has been picked up by the few countries who still find themselves in a position to take financial leadership.

Individual states no longer have the option of printing their way out of a debt crisis. Default is only avoidable by seeking loans from others. And this means playing by the rules of others.

The long-term legacy of the EU crisis therefore is to turn national inequality into regional inequality where countries such as Germany are able to dictate the economic policies of countries such as Greece and Spain. The shift of power is not necessarily in the favour of the powerful, however, and the shift of responsibility comes with a great burden.

The money to bail out countries that are at risk of defaulting needs to come from somewhere. While the International Monetary Fund will contribute, it is up to the European nations to solve the problem. Germany already carries a public debt of 81 percent of its gross domestic product and of the six remaining EU members that are AAA-rated by Moody’s Investors Service, only Finland is not at risk of a downgrade.

If Germany and other lenders have miscalculated their demands on the countries that are borrowing (such as strict austerity measures to curb spending) and reform measures do not work, then the sinking periphery states, unable to take control of their own situation, may end up dragging the rest of the EU with them. And as the EU is South Africa’s main export market, the effect of the ebbing tide will hit hard here.