Australia cuts rates to historic low of 1.5% to head off deflation

Australia’s central bank cut its cash rate a quarter point to an all-time low of 1.5 per cent on Tuesday, the second easing this year, as it seeks to defend the economy from creeping deflation and restrain a too-strong currency.

The local dollar did initially retreat on the Reserve Bank of Australia’s (RBA) widely expected move. But it quickly rebounded as investors anticipated easings by other central banks, underlining the challenge of keeping the currency down in a world where negative rates are now commonplace.

“The Reserve Bank is clearly on a mission to avoid the near zero inflation rates that many similar countries have,” said Shane Oliver, chief economist at AMP Capital Investors.

“With the inflation numbers so low and the risk that if they didn’t cut that the Aussie dollar would have been 76-77 (US cents) by now, they felt they probably had to act.”

The Aussie was last at $0.7528, having been as low as $0.7486 at one stage. That resilience is a major reason the market is already pricing in the possibility of a further rate cut to 1.25 percent.

Interbank futures imply a 68 per cent probability of a further easing by December. Likewise, yields on three-year government debt dropped to 1.39 per cent, making it cheaper than borrowing overnight.

Monetary policy outlook

RBA Governor Glenn Stevens, who retires next month after a decade at the helm of the central bank, was characteristically tight-lipped on the outlook for policy.

“The Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting,” said Stevens, while noting that inflation would likely be low for an extended period.

Data out last week showed consumer price inflation slowed to 17-year lows in the June quarter while underlying inflation hit an all-time trough of 1.5 per cent.

That was well short of the RBA’s long-term target band of 2 to 3 per cent, suggesting the economy needed to grow faster if disinflation was not to become the new norm.

Less risk from housing

Neighbouring New Zealand is already stuck in that trap, with inflation at just 0.4 per cent and its central bank under intense pressure to cut rates at a policy meeting next week.

Japan, long locked into deflation, added to its stimulus campaign last week and analysts fully expect the Bank of England to resume easing on Thursday.

A hike from the Federal Reserve would help by lifting the US dollar, but officials there seem in no hurry to act.

There have been concerns that ever lower rates would merely fuel a borrowing binge in the housing market, a real risk given Australian households are among the most indebted in the world.

Commonwealth Bank was quick to trim its variable mortgage rate to 5.22 per cent, though a raft of special offers mean it is fairly easy to pay less than 5 per cent.

Yet cheap borrowing costs have also driven a boom in home building, which looks to be taking some of the steam out of house prices.

Figures from property consultant CoreLogic out this week showed annual growth in home prices for Australia’s capital cities slowed to 6.1 per cent July, down from 8.3 per cent in June and a long way from last year’s peak above 11 per cent.

The RBA’s Stevens himself noted that a large supply of apartments would come on stream over the next couple of years, and lending for property investment had slowed.

“All this suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished,’’ said Stevens in his post meeting statement.

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