Goldman Joins Deutsche Bank on RBA Cuts as Growth Slows: Economy

By Michael Heath  

Photographer: Brendon Thorne/Bloomberg

Commercial buildings stand in the central business district in Sydney, Australia.

Goldman Sachs Group Inc. joined Deutsche Bank AG in predicting Australia’s central bank will be forced to resume cutting interest rates as growth slows.
Both institutions expect the cash rate will be lowered to 2 percent next year from the current record-low 2.5 percent. Money markets are pricing in an 88 percent chance the Reserve Bank of Australia will implement a quarter point cut in the next 12 months after government data today showed the economy grew just 0.3 percent last quarter, less than half the rate economists forecast.
“The composition of growth was poor,” said Tim Toohey, Goldman Sachs’s Melbourne-based head of economics and strategy for Australia. “With income in retreat, mining construction activity in deep decline, disappointing consumption growth, contracting housing construction, and
falls in domestic demand in all mainland states outside of New South Wales.”
Slower growth together with a slump in the price for iron ore, which accounts for one-fifth of Australia’s export income, has turned some RBA watchers to the view that its policy of patience is insufficient. Royal Bank of Canada today dropped its prediction of a rate increase next year and Macquarie Group Ltd.’s James McIntyre said stimulus may be needed in 2015.
“It’s likely the RBA will be revising their growth forecast down again,” McIntyre said. “It’s going to raise questions between now and February and in the first half of 2015 in the leadup to the budget whether or who might deliver additional policy stimulus to the economy.”

Salt Away

The RBA, which held rates steady at a meeting yesterday, will next decide on policy on Feb. 3.
The central bank has been trying to encourage spending by consumers and companies to offset falling mining investment. Australian firms, outside of property, have opted to pay dividends or salt away cash rather than invest in new projects as they wait for increased household demand, which has been damped by an 11-year-high unemployment rate.
Toyota Motor Corp., which announced in February it would stop making cars in Australia, said today it expected larger job losses as it becomes just a distributor of imported vehicles in the country in 2018. The Japanese carmaker estimates its workforce in Australia will fall to around 1,300 people from 3,900, according to an e-mailed statement.
The local dollar slumped following today’s gross domestic product report to a four-year low of 83.89 U.S. cents. It traded at 84.05 cents at 5:57 p.m. in Sydney from 84.62 cents before the release.
The weak result is another challenge for Prime Minister Tony Abbott’s government as it struggles to pass spending cuts and tax increases through Parliament to try to narrow Australia’s budget deficit.

‘Dramatic Fall’

“We have seen a dramatic fall in commodity prices, which has obviously had an impact on the Australian economy, had an impact on our nation’s income,” Treasurer Joe Hockey told reporters in Canberra today. The government is determined to continue “the structural repair of the budget,” he said.
After taking account of population growth, GDP per person was unchanged in the quarter and up just 0.9 percent from a year earlier, today’s report showed.
Income in the economy shrank 0.4 percent in the third quarter after a 0.3 percent contraction in the second quarter -- a technical income recession. Real gross domestic income measures the purchasing power generated from production and its contraction last quarter, compared with the increase in overall GDP, reflects the fall in commodity prices.

Soft Numbers

“We were expecting soft numbers, but not that soft,” said Westpac Banking Corp. Chief Economist Bill Evans. “There was a substantial fall in government expenditure and mining investment. They’ve been the two biggest headwinds for the economy in recent times and this quarter really highlights that.”
Compared with a year earlier, the economy expanded 2.7 percent in the third quarter, today’s report showed. The median forecast of economists was for a 3.1 percent rise.
Non-dwelling construction fell 6.7 percent from the previous quarter, subtracting 0.6 percentage point from GDP growth. Machinery and equipment advanced 7 percent, adding 0.3 point, while household spending rose 0.5 percent, adding 0.3 point.
The data underscore a division in policy outlook between the Federal Reserve, which markets bet will tighten next year, and the RBA’s flagged period of stability. Australia is losing its developed-world-beating status as the mining investment boom wanes, while the associated currency strength fails to dissipate.

Near-Zero

The Australian dollar averaged just over 97 U.S. cents in the past three years, compared with just over 73 cents in the prior two decades, spurred by the resource-investment boom and near-zero interest rates in the U.S. and Japan.
While the currency has eased more recently, declining 10 percent in the past three months, it hasn’t fallen as quickly as prices for the country’s key commodities.
RBA Deputy Governor Philip Lowe, asked last week about the value of further rate cuts for the economy, said the nation’s monetary transmission mechanism was “thankfully” still working, unlike in some countries.
“If further interest rate reductions were required, they would have some effect in stimulating economic activity,” Lowe said Nov. 25. “You get to the point where the confidence effects don’t seem to be as strong as they were in more normal times. I don’t think we’re there.”

Currency Risk

Goldman, Deutsche Bank and RBC said a risk that could dissuade the RBA cutting again is an accelerated drop in the currency.
“Much will depend upon whether the Australian dollar can fall sufficiently fast to offset the contractionary effect of commodity prices on financial conditions, however, at this stage financial conditions have tightened materially through 2014 suggesting a much greater decline in the Australian dollar will be required,” Toohey said.
Australia’s jobless rate stands at 6.2 percent, meaning there is spare capacity in the labor market, and wages growth is weak, hurting consumer spending.
Goldman’s Toohey expects unemployment to climb toward 6.5 percent by the third quarter next year, and Deutsche Bank predicted it to rise to a peak of about 6.75 percent.
“The hurdle to cut further remains high,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at RBC. “But the bar may have been lowered somewhat as the weaker terms of trade dynamic feeds through the nominal and real economy and shifts the balance of risks.”