RBA optimism boosts dollar, bond yields

The Reserve Bank’s optimism and reluctance to keep cutting interest rates has continued to support the Australian dollar

Reserve Bank Governor Philip Lowe. Picture: AAP

The Reserve Bank’s optimism about the economic outlook and its reluctance to keep cutting interest rates has continued to support the Australian dollar and bond yields after a recent tumble caused by an expected economic shock from the coronavirus outbreak in China.

After hitting four-month lows this week as the coronavirus outbreak worsened, the dollar jumped about 20 points to US67.45c, 10-year government bond yields rose 11 basis points to 1.03 per cent, and the S&P/ASX 200 share index rose 0.4 per cent to 6976 points — with help from offshore gains after the People’s Bank of China ramped up its financial support measures to offset a downturn.

It came as the market-implied chance of a rate cut continued to slip, with another 25 basis point cut not expected until September, whereas before the RBA meeting this week it was expected in May.

In a landmark speech to the National Press Club in Sydney, RBA governor Philip Lowe said the recent bushfires would reduce growth by about 0.2 per cent over the December and March quarters, the drought would shave about 0.25 percentage points off growth over the year, and the coronavirus outbreak was “a new uncertainty affecting the outlook”.

But while Dr Lowe noted that hits from bushfires and drought were “a stark reminder that the economic effects of these climate events are material”, the RBA’s expectation is that rebuilding after the bushfires will mean that growth for 2020 as a whole would be largely unaffected.

As for the coronavirus outbreak, he said it was “too early to tell”, even though the SARS outbreak in 2003 saw a sharp slowdown in China for a few months before a sharp bounce-back as the outbreak was controlled and economic stimulus measures were introduced.

“Today, China is a larger part of the global economy and it is more closely integrated — including with Australia — so the international spillovers could be larger than they were back in 2003,” Dr Lowe cautioned.

But he touted Australia’s “very strong” economic fundamentals including its natural resources, highly skilled workforce, established regulatory system, sound public finances, diverse and growing population and links to strong growth in Asia.

After cutting its official cash rate three times to a record low of 0.75 per cent last year, the RBA had decided to hold the cash rate steady, he said, recognising the “significant monetary stimulus already in place and the long and variable lags associated with monetary policy”.

He also said it reflected “a judgment about the benefits from a further reduction in interest rates against some of the costs and risks associated with very low interest rates”.

“It certainly remains the case that a further reduction in interest rates would help with the balance sheet adjustment by households with existing debt, which should help bring forward the day that consumption strengthens,” Dr Lowe said.

“It would also have a further effect on the exchange rate, which would boost demand for our exports and therefore support jobs growth.

“On the other side of the equation though, there are risks in having interest rates at very low levels.”

Dr Lowe noted increased concerns globally about the effect of very low interest rates on resource allocation and their effect on the confidence of some people.

He also warned that lower ­interest rates could encourage more borrowing by households eager to buy residential property when there was already a strong upswing in housing prices in place.

“If that occurs, this could increase the risk of problems down the track,” he said.

But the central bank believed the “balance” between the risks and rewards from interest rate cuts could “change over time and that it depends very much upon the state of the economy”.

“If the unemployment rate was to be trending in the wrong direction and there was no further progress being made towards the inflation target, the balance of arguments would change,” Dr Lowe said.

“In those circumstances, the board would see a stronger case for further monetary easing.

“We will continue to monitor developments carefully, including in the labour market, as we seek to strike the right balance in the interests of the community as a whole.”

In answer to a question, Dr Lowe said “the probability of an interest rate increase any time soon is very low” and while it was “possible that interest rates could come down, I’m hoping that does not happen, because the scenario in which we would be reducing interest rates is one where we’re not making progress towards full employment and the inflation target.”

He said it was reasonable to expect “a period of stability” on rates and he expected the economy to benefit from household balance sheet repair, a rising housing market, a residential construction sector upswing, and expanding resources-sector invest­ment.

“If we don’t see that progress, or we see that it’s a serious risk, it’s right to have interest rates back on the agenda,” he said.

Dr Lowe also said that whether the government recorded a small budget surplus or deficit “is not ­really economically important”, but what occupied the bank was the potential “for government policy to stimulate investment”, particularly in the private sector, at a time when businesses have the opportunity to borrow at rates which were at “lowest since Federation”.

ANZ’s head of Australian economics, David Plank, said the “patient” stance of the RBA meant that “it will likely take more than a few disappointing employment reports for it to become clear that the unemployment rate is trending higher.”

“This suggests our expectation of another rate cut in April needs to be reconsidered, regardless of the downside risks to the economy posed by the bushfires and coronavirus,” Dr Plank said.

It came as ANZ forecast a negative quarter-on-quarter economic growth rate of minus 0.1 per cent for the Australian economy in the March quarter as it predicted a contraction in economic growth of about 0.5 percentage point due to the coronavirus outbreak and a small hit from the bushfires.

“For the RBA, a case can be made for looking through the immediate impact on demand, given the likely rebound later in the year,” Dr Plank said. “Our view, however, is that while the economic impact of the coronavirus does not drive the case for further easing, it adds to the weak tone in the economy and suggests further rate cuts are likely this year.