Why the Reserve Bank of Australia are in denial

Over the past two RBA monetary policy meetings, the minutes released have revealed a somewhat positive outlook on the housing market. The minutes for the September 3rd meeting reiterated the view that the housing sector has continued to show signs of development. It also outlined that low interest rates have contributed to the improvement in the housing sector.

What is worrying here is the fact that the central bank has failed to identify how this could contribute to another boom-bust housing cycle. Australian homes are already regarded as overvalued, and as the mining boom cools, it is easy for the central bank to become more reliant on the housing sector as a source of growth. The recent uptrend in housing figures from Australia has confirmed this, and with household debt currently at 150% of GDP the Australian housing market is definitely something to monitor.

Even the Aussie’s neighbours have taken steps. The central bank of New Zealand have already acknowledged the potential risk to their economy and have put in place macro prudential policies, such as loan to value ratio restrictions, in order to curb housing related credit growth and price pressure. RBNZ Governor Wheeler outlined that this would help better position banks in the event of shocks, limiting damage to the housing sector and the economy.

The chart below shows the world’s most overvalued economies, with Australia not too far behind New Zealand.

Source: OECD

Chart 2 allows us to analyse the effects of the base rate against house prices more closely. From this we can see that when interest rates were higher, house prices rose more steadily, such as the period from 2005 through to March 2008. As the global crisis took hold in 2008 house prices plummeted and rates were lowered in order to support the economy. The lower rate then fuelled a sharp acceleration in house prices which tumbled shortly after, highlighting the significance of lower interest rates to house prices. The problem is the RBA fails to recognise that the effects of record low interest rates are already being seen. If the central bank needs to cut rates further to support economic growth, we could potentially see the housing market spiral out of control. In addition, the RBA has stated that a weaker Aussie will help the recovery, but a weak Aussie, coupled with high household debt that is likely to increase if rates are cut further, can easily create turmoil in the housing market and vulnerability to shocks.

RBA Asst Gov Malcolm Edey has said we should not rush into a bubble analogy, but surely recognition and consideration of the potential longer-term effects, of an already overvalued housing market is not too much to ask? Especially considering we have witnessed the repercussions when such signals are ignored.

Sasha Nugent

Currency Analyst

Caxton FX 

Will the Reserve Bank of Australia cut interest rates in December?

We expected the Reserve Bank of Australia to cut interest rates at the start of November but Governor Stevens & Co decided to stay put with the 3.25% base rate. In our defence, this was pretty close to a 50:50 call. We still view the RBA as more likely than not to cut the rate by 0.25% in the early hours of next 

Tuesday morning (December 4^th). Of course, there are still clearly risks of another non-event, but in the last few days, the market appears to have come around to our way of thinking.

The minutes from the last RBA meeting were noticeably dovish, despite electing not to cut the interest rate, as indicated by the phrase “members considered that further easing may be appropriate in the period ahead.”

There have been mixed signs in terms of aussie data in the past month. Wage price growth data slowed right down, as did consumer inflation expectations, which both point to monetary easing. However, China’s manufacturing sector grew for the first in 13 months, which has made things a little more complicated.

The slowdown within the recent quarterly private capital expenditure figure has once again strengthened the case for a rate cut, as has this morning’s weak Australian private sector credit data. The decision last time was a close call; these figures should have tipped the balance in favour of a cut.

The peak in the mining boom is fast approaching, while the aussie government remains committed to fiscal tightening. The Australian economy should be in for an early Christmas present next week!

Richard Driver

Currency Analyst 

Caxton FX

Reserve Bank of Australia cuts growth prospects

The news as far as the aussie dollar has been concerned this week has been remarkably positive. We have to hold our hands up and say that we were expecting the RBA to cut its 3.25% interest rate again at its meeting this week, though we did warn that it was an incredibly close call. On top of this, data revealed that 10.7 thousand jobs were added to the Australian labour market, which was away ahead of expectation. The aussie unemployment rate also unexpectedly remained 5.4%.

What followed all this was last night’s RBA monetary policy statement. In it, the RBA warned that the aussie mining boom will peak earlier and at a lower level than has previously been thought. It was previously thought that the mining boom would peak at 9.0% of GDP, expectations are that it will now peak at 8.0%. The central bank also complained further about the strength of the Australian dollar (change the record!)and proceeded to downgrade aussie GDP projections for this year from around 3.00% to around 2.75%, though admittedly we might have expected this downgrade to be more drastic.

The RBA stated that the current interest rate is appropriate and that past rate cuts are still filtering through and benefiting the Australian economy. The statement also sounded confident that the Chinese economy has stabilised, anticipating a gradual recovery in growth from here.

We suspect that Governor Stevens may be getting ahead of himself with respect to Chinese growth and Australian growth. While this week’s strong aussie jobs data may see the RBA delay a rate cut in December, we’d be surprised if we had to wait past January for another cut. 

Richard Driver,

Currency Analyst

Caxton FX

What can we take from the RBA minutes?

Last night’s Reserve Bank of Australia minutes were unsurprisingly dovish given the downturn in Chinese and global growth over the past few weeks and months. The minutes explained the key drivers behind the central bank’s decision to cut interest rates at its meeting earlier this month. As well as slower growth in Asia, lower commodity prices and weaker domestic growth also topped the RBA’s list of concerns. The bank is now envisaging a peak in resource investment, sooner and lower than initially estimated.

An ongoing decline in coal coking prices is alarming the RBA and there are reports of early closures of older mines and low take-up of new resource projects. The mining boom has been a huge driver of Australian growth in recent years and these tell-tale signs of decline are bad news for the economy and the AUD as a result. Weakening demand from the eurozone is clearly taking its toll on Chinese growth and the knock-on effect is weaker demand for Australian commodities.

The RBA is also very concerned about the aussie labour market. We have had a decent Australian employment update this month but the unemployment rate has climbed up to two-year high of 5.4% and the central bank is anticipating a deterioration in the coming months, in no small more part due to projected mining sector weakness. The mining sector has masked underlying weakness in the labour market for a while now, the truth should now emerge. 

Australian Treasurer Swan indicated last month concerns over a fall in Australian tax receipts, while the Government is committed to returning to a budget surplus. The difference is being made up in budget cuts, which will also weigh on Australian growth in the coming months.

Amid all these downside risks to Australian growth and the noticeably dovish tone in these latest RBA minutes, we are expecting another interest rate cut at the RBA’s next meeting in November. October 24 brings a key quarterly Australian inflation figure but an upside surprise does seem very unlikely and the path should be clear for another rate cut. This leaves plenty of scope for AUD-weakness in the coming weeks and months. 

Richard Driver

Currency Analyst 

Caxton FX

The aussie dollar is flying high but where does it go from here?

Australian dollar has gained by over 6.5% over the pound in the past two months, strengthened by nearly 7.5% against the USD in the past six weeks, and hit fresh record highs against the euro only this afternoon. The Reserve Bank of Australia cut its interest rate to 3.50% in early June and its key trading partner China continues to slowdown, so what is driving this latest rally in the aussie dollar?

One major factor fuelling the current positivity towards the AUD is the development that the German central bank, the Bundesbank, is set expand its portfolio of Australian assets. The eurozone crisis has caused central banks all over the world to review their reserve allocations and among others who are set to invest in Australian assets is the Czech central bank. This factor has completely overshadowed any dampening effects you might have expected as a result of the collapse of risk appetite that saw many higher-yielding currencies and equities decline since early May.

In addition, Australian economic data has in general held up remarkably well given the decline being seen in the Chinese economy (Chinese GDP has slowed down from a pace of 9.5% to 7.6% in the past year). Recent data revealed that Australian GDP expanded by an impressive 1.3% in Q1 of this year, well up from Q4 2011’s figure of 0.6%. This domestic economic strength gave the Reserve Bank of Australia the confidence not to cut its interest rate again in July.

However, we are seeing considerable risks of a rate cut in August as this domestic performance looks unlikely to persist. Recent Australian data has taken a downturn, particularly in terms of the domestic labour market. As well as July’s weak labour numbers, forward-looking indicators point to further softness.

Importantly, data revealed a sharp drop in Chinese imports from Australia in June and weekly New South Wales coal shipments have also fallen off this month. Equally, Chinese steel production has declined and its iron ore inventories have climbed, suggesting waning demand for aussie exports in the months ahead. As well as further deterioration in Chinese growth, we take a gloomy view as to the outlook for global growth and financial conditions, driven not least by eurozone risks. If a rate cut doesn’t come in August, we would be very surprised if it didn’t come in September.

For these domestic and international reasons, we see the AUD rally halting soon. AUD/USD should fail to sustain any breach of 1.05 and we should see this rate head back down toward and below parity in the coming months. In terms of GBP/AUD, downside scope is looking increasingly limited. The aussie is deep in overbought territory and we expect 1.55 will be seen once again before long. In addition, when the aussie dollar does endure its downward correction, it could well be quite a brutal move.

Richard Driver
Analyst – Caxton FX
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Weekly Round-Up and end of week forecast

European bond yields in focus

Eurozone bond yields have very much come into focus in recent weeks. Italian 10-year debt climbed above the 7% mark, considered the level at which borrowing costs become unsustainable. Spanish debt is also coming under major pressure despite a strong election victory by the conservative Populist Party. There has been little good news to come out of the eurozone in recent weeks; a Greek referendum was avoided and Berlusconi’s resignation was finally tendered, but too much uncertainty surrounds the future of the eurozone for the single currency to truly benefit.

The eurozone economy is almost certainly headed for a recession, though the UK economy is also looking very vulnerable to contraction. The euro has sold off badly in recent weeks as a result, falling almost eight cents from the $1.42 level we saw in late October, and sterling has gained three cents from late October lows close to €1.13.

As well as soaring Italian and Spanish bond yields, and the alarming impact they are having on core eurozone bond yields such as France and Austria, the issue of what role the ECB is to play in a long-term plan to deal with debt crisis remains contentious. The Greek situation also remains unresolved, they still need to persuade IMF and EU chiefs to release their next instalment of aid under last year’s bailout agreement, and the second bailout agreement still needs approval. For these reasons and many more besides, the euro is struggling and we view the risks to be firmly skewed to the downside.

US debt concerns return to weigh on risk appetite further

After the panic we saw in the summer surrounding the raising of the US debt ceiling and the 11th hour agreement between the Republicans and the Democrats on cutting the America’s enormous pile of debt, the US fiscal story is back in the headlines. The ‘supercommittee’ given the task to come up with a plan on how to reduce US debt looks highly likely to announce a failure to agree later today.

At the moment, the nervousness caused by the US debt issue is benefiting the dollar significantly. However, if other credit rating agencies follow Standard & Poor’s August removal of America’s AAA credit rating, the dollar really should stand to face some pressure in the longer-term. Spending cuts will need to be agreed and implemented to appease the rating agencies and in turn the market.

Sterling remains fairly resilient to poor UK data

News from the UK economy was negative last week; domestic inflation weakened and unemployment soared in October and the Bank of England has slashed UK growth prospects for next year. It is now a case of “when” not “if” the MPC decide on further quantitative easing. Wednesday’s MPC minutes will be watched closely for this key issue, but early next year seems most likely. Nonetheless, this has been priced in to some extent.

After a very tough start to the week, sterling is trading down at 1.16 against the euro. We still hold the view that safe-haven UK gilt-buying will push the GBP/EUR pair higher towards €1.20 as we close out the year. Against the dollar we are less optimistic; a gloomy outlook for the debt situation in the US and the EU, as well as an ongoing slowdown in growth across the globe should see risk averse trades continue to benefit the US dollar.

End of week forecast:
GBP / EUR 1.17
GBP / USD 1.57
EUR / USD 1.34
GBP / AUD 1.60

Richard Driver
Senior Analyst – Caxton FX

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The Aussie, the Kiwi and the Loonie- will the good old days of two or three to the pound return?

GBP/AUD: 1.56

GBP/NZD: 2.10

GBP/CAD: 1.56

These are the current interbank rates for sterling against the aussie, the kiwi and the loonie (Canadian dollar). Four years ago, one pound would buy you two and half aussie dollars, almost three kiwi dollars, and well over two Canadian dollars. These levels are reflective of historically riskier currencies versus the size and safety of the UK economy in years gone by. So, will we see these sorts of levels again or must be consigned to a new trading range?

In the case of the export-driven Australian and New Zealand economies, these have benefitted on a huge scale from the rise of China. Now the world’s second largest economy, China is a major trading partner to these two antipodean nations, and with commodity prices so high, their currencies have appreciated strongly. The higher interest rates of these two economies has for the past few years also provided investors with a far higher yield than those available in the UK, the US or Japan for example. This interest rate differential is set to be maintained for at least the next couple of years to come. The global recession hit the UK far harder than either Australia or New Zealand and it will take some time yet before a full recovery is established and it cope with fully normalised monetary policy (ie higher interest rates).

The loonie has also had reason to perform well, though for different reasons. Canada’s economy has benefitted from a broad rise in oil prices and from improving conditions in the US economy, its main trading partner. Canada’s economic fundamentals are solid – far more so than the UK’s - and the loonie had appreciated against the pound despite having equally low central bank interest rates.

None of the factors that have caused these ‘growth-linked’ currencies to appreciate against the pound, particularly the strength of the world’s two largest economies, look likely to fade any time soon. It would therefore be of huge surprise even in the long term to see a return of the levels of four years ago. The outlook for the British economy, in comparison to the “riskier” ones discussed above, looks distinctly pessimistic. With UK suffering economic contraction in the last quarter of 2010 and continuing to struggle with persistently high inflation, it might be argued that sterling is presently a riskier currency than the aussie dollar on a fundamental level. The day the pound has fully regained, for instance the near 40% it has lost against the aussie in the past 4 years, looks a very long way off indeed.

Although we actually view sterling to be undervalued at present (many others do not), it certainly appears that the current lowly trading ranges are set to continue for some time.

Richard Driver
Analyst – Caxton FX


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