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Australia cuts interest rates to turn back global deflation tide

business Updated: May 03, 2016 12:22 IST

A board displaying stock prices at the Australian Securities Exchange (ASX) in Sydney, Australia, on Wednesday.(REUTERS)

Australia’s central bank cut interest rates to an all-time low of 1.75% on Tuesday, the first easing in a year as it seeks to restrain a rising currency and insulate the economy from creeping deflation.

The Reserve Bank of Australia’s (RBA) quarter-point cut sent the local dollar down more than one US cent as markets wagered a further move to 1.5% was now likely.

The Australian dollar skidded 1.4% to $0.7561 on the day. A break of $0.7548 would target the April low of $0.7490.

The Aussie dropped to its lowest in two months against the yen, euro and pound , while it touched a six-month trough versus its Canadian peer.

Banking stocks took off on the prospect of increase demand for mortgages, lifting the benchmark index 1.8%.

Speculation of a possible cut flared last week when government data showed inflation had slowed far more than expected in the first quarter of the year.

Underlying inflation dropped to a record low of 1.5%, taking it well under the RBA’s long-term target band of 2% to 3% and effectively pushing real rates higher.

“Inflation has been quite low for some time and recent data were unexpectedly low,” RBA governor Glenn Stevens said in a brief statement after the bank’s May policy meeting.

“These results, together with ongoing very subdued growth in labour costs and very low-cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.”

Central banks around the globe have been taking ever more exotic steps to reflate their economies, chopping rates under zero and buying trillions worth of assets.

That easing abroad has in turn boosted the Australian dollar further than the RBA desired, hurting exports and tourism while pushing down import prices and, hence, inflation.


All of which argued for at least one cut in rates to offset these tighter financial conditions, and markets were quick to price in the possibility of a further move.

“It’s hard to see how one cut by itself is going to do much,” said Commonwealth Bank chief economist Michael Blythe.

“So you’d have to think the odds on a follow-up have also increased, very much tied in with how the inflation outlook evolves from here. August would be the most obvious timing.”

While Australia is still struggling with the unwinding of a massive mining boom, economic activity has been generally favourable. Growth was a surprisingly brisk 3% for 2015 and unemployment recently fell to a 30-month low of 5.7%.

The RBA had also been reluctant to risk a debt-fuelled bubble in the housing market, though it said dangers to that sector had diminished in recent months.

The easing comes just hours before the conservative government of Prime Minister Malcolm Turnbull reveals a budget that is considered crucial for his chances in a likely July election.

Normally a rate cut and resulting falls in mortgage rates would be considered a political positive in Australia. Yet this cut could also raise an awkward question - if the economy was doing as well as Turnbull claimed, why would it need lower rates?