SYDNEY (Reuters) - Australia’s central bank cut interest rates by a surprisingly aggressive half a point on Tuesday and said inflation would likely be lower than expected for the next two years, leaving the door ajar for further easing if needed.
The local dollar fell about three-quarters of a cent and government bond yields hit 60-year lows as the Reserve Bank of Australia (RBA) cut its cash rate to 3.75 percent, a level not seen since late 2009. Markets had predicted only a quarter point easing.
Driving the larger move was the need to get mortgage rates down to stimulative levels given local banks have been nudging up their rates to cover higher funding costs.
“A reduction of 50 basis points in the cash rate was, in this instance, therefore judged to be necessary in order to deliver the appropriate level of borrowing rates,” RBA Governor Glenn Stevens said after the bank’s monthly policy meeting.
A move had been widely expected given a background of benign inflation and disappointing economic growth. In a Reuters poll of 22 analysts, 21 had expected a cut of 25 basis points, with another cut for June.
“This 50 basis-point move will lead to a decent reduction in borrowing costs,” said Shane Oliver, chief economist at fund manager AMP Capital. “The economy is not certain to recover just because of this. We will probably see cash rates down to 3.25 percent by the year-end.”
Rates are now the lowest since December 2009, but still far above those in the United States, Japan and Europe.
And that’s one reason investors are pricing in a further 70 basis points of cuts within a year. If they are right, that would see rates near the record lows of 3 percent plumbed during the depths of the global financial crisis.
Tuesday’s easing was greeted warmly by a Labor government that is trailing badly in opinion polls yet is set to deliver a tough budget next week aimed at returning to surplus years before most other developed economies.
“This is the interest rate cut that households and small businesses have been hanging out for,” Treasurer Wayne Swan told a news conference. “It is well deserved and it is certainly much needed by households under financial pressure.”
It also lowered the government’s borrowing costs, with yields on 10-year bonds diving to 3.55 percent, the lowest since the early 1950s.
Australian households are highly sensitive to mortgage rates as over a third have home loans, most of which are variable. Mortgage debt totals around A$1.2 trillion, or 1.5 times household disposable income, and paying the annual interest on it takes almost a tenth of those earnings. A reduction of 50 basis points in the standard variable mortgage rate saves an average borrower around A$1,080 a year.
Australia’s banks are expected to only pass on some of this easing to their customers, choosing instead to maintain profit margins in the face of higher funding costs. Australia’s household savings rate is around 9 percent of disposable income, more than twice that of the United States, so savers will feel the pinch of the rate cut.
The RBA has been on hold since cutting rates last November and December, but recently adopted an easing bias as growth in the A$1.4 trillion economy disappointed outside the booming mining sector.
A strong currency and intense foreign competition has pressured manufacturing and tourism, while a shift in spending habits by penny-pinching consumers has hit retailers hard.
One result has been a sharp slowdown in employment growth, though the jobless rate remains historically low at 5.2 percent.
Housing has been particularly weak with the government’s measure of city house prices falling 1.1 percent in the first quarter, twice the drop forecast. Prices were down 4.5 percent on the same quarter last year, a far cry from the heady growth pace of 19 percent seen as recently as 2010.
Still, the lofty local dollar has also helped restrain inflation by driving down prices for a whole raft of imported goods, from cars to computers, clothes and TVs.
The RBA’s preferred measure of underlying inflation braked to a decade low around 2.15 percent in the first quarter, near the floor of its long term target band of 2-3 percent.
The RBA is now expected to cut forecasts for both economic growth and inflation in its quarterly statement on monetary policy, to be released on Friday.
“Over the coming one to two years ... inflation will probably be lower than earlier expected, but still in the 2-3 per cent range,” Stevens said on Tuesday.
Reporting by Wayne Cole; Editing by Ian Geoghegan