Australia Rate Decision - RBA Has 3 Choices

February 2, 2009

Compared to other G10 nations, the slowdown in the Australia’s economy has not been as deep. Of the eight major central banks, Australia currently has the highest interest rate. This evening, the RBA will be faced with the tough decision of cutting interest rates once again. The market is currently looking at an aggressive 100bp rate cut which would match their last rate cut in size. Like the Reserve Bank of New Zealand, Australia has been late to cutting interest rates and they are making up for it now. In 2008, they cut interest rates by 300bp in 4 months. Tomorrow, rates are expected to fall to a five decade low of 3.25 percent. The concerns affecting Australia are mainly growth related. The sheer nonexistence of viable trading partners and declines in commodity prices has altered growth prospects severely to the downside. Former RBA Governor Bernie Fraser has not been quiet in his predictions for an overwhelmingly deep and long-lasting Australian recession. To add some validity to his forecasts, Consumer Confidence, the Unemployment Rate, Value of Loans, Retail Sales and Trade Balance have all suffered in recent months. In addition to an economically crippling narrowed trade balance, the country is now dealing with a Federal Budget Deficit as a result of the increased spending on economic stimulus. Only the NAB Business Confidence and the Employment Change managed to post improving results.

However a full percentage rate cut is not a done deal. The Australian dollar has been weak which is boosting inflationary pressures and that may push the RBA to consider a smaller 75bp rate cut. If they under deliver, it should be positive for the Australian dollar. On other hand, the central bank of New Zealand shocked the markets by cutting interest rates 150bp. If the RBA wants to be aggressive and ahead of the curve, they could also follow in the RBNZ’s footsteps with a 125bp rate which would be bearish for the Aussie. Unlike the US, Japan, Switzerland and even the Bank of England, the RBA is not running out of room to cut interest rates. Therefore keep an eye on the comments from the central bank following the rate decision. Talk of continued rate cuts could drive the Australian dollar lower.

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Posted in Australian Dollar, Reserve Bank of Australia, forex blog