Australia: Inflation’s Been Mellow, RBA Rate Cut Eyed

Lackluster consumer prices in Australia have spurred many in the market to think the Reserve Bank of Australia may well cut its cash rate in the near-term.

A slower-than-expected rate of inflation in the first-quarter of 2019 spurred a plunge in the value of the Australian dollar, as well as shook yields on shorter-dated government debt.

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The Consumer Price Index (CPI) rose 1.3% year-on-year in the March quarter 2019, compared with a rise of 1.8% over the twelve months to the December quarter 2018. Overall, inflation was flat (0.0%) in Q1’19, compared with a rise of 0.5% in the prior three-month period.

According to the Australian Bureau of Statistics, the most significant price increases in the latest data include vegetables (+7.7%), secondary education (+4.2%) and motor vehicles (+2.4%), while the largest declines were highlighted by automotive fuel (-8.7%) and domestic holiday, travel and accommodation (-3.8%).

In response to the softer CPI figures, Australia’s local currency and public debt generally took downward turns.

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Marc Chandler, the chief market strategist at Bannockburn Global Forex, observed that the Aussie was the “weakest” of the major currencies, having fallen around 0.8% Wednesday morning to below 0.7030 – its lowest level since mid-March.

Furthermore, the Relative Strength Index (RSI) on the AUD/USD pair fell below 30 Wednesday to 27.562 – indicating oversold conditions – from 39.852 Tuesday, according to the IBKR Trader Workstation (TWS).

Meanwhile, the yield of the nation’s two-year government notes slipped more than 15 basis points to about 1.295%, and the three-year fell 17bps to a low of around 1.250%.

Potential for rate cut rises

Following the softer inflation figures, market participants’ expectations for the RBA to cut its cash rate generally seemed to escalate.

In fact, in the latest release of the Board’s meeting minutes, members of the central bank had discussed how weaker-than-expected data – notably the December quarter national accounts – have fueled the financial markets to anticipate a near-term lowering of interest rates.

At the RBA’s monetary policy meeting in early April, the Board elected to leave the cash rate unchanged at 1.50%, where it has resided since July 2016. The central bank is slated to decide on its next monetary policy move on May 7.

In the meantime, investors will receive a host of fresh economic data in the week ahead, providing further insights into Australian growth prospects, including its manufacturing, services and housing sectors.

Among the reports, details about Australia’s manufacturing performance are scheduled for release Tuesday from the Ai Group, as well as Commonwealth Bank Australia (CBA).

Tuesday, April 30

• Ai Group Manufacturing (Apr)
• CBA Manufacturing PMI – Final (Apr)

The Australian Industry Group Australian Performance of Manufacturing Index (Australian PMI) fell further in March from the prior month to 51 from 54. The slower pace of expansion followed a stronger month in February but a flat end to 2018.

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The Ai Group said the Australian PMI has been stable or positive (50 points or higher) since August 2016 but has been trending lower since mid-2018.

Respondents partly attributed the latest deceleration to a downturn in local housing construction, which affected demand for building-related manufactured goods.

Drilling into the details, the index for the building materials, wood, furniture, and other manufacturing products, including glass, bricks, cement, timber and furniture, fell a further 2.5 points to 44.7 points in March from the prior month – and the lowest reading for this sector since July 2013.

Ai Group added that demand for building-related products and furnishings has “dropped sharply since this sector peaked” in September 2018, and recent declines in monthly building approvals suggest a slower year ahead in 2019.

Commonwealth Bank and IHS Markit recently provided further evidence of Australia’s slowing manufacturing industry, after they observed growth had reached the softest pace since July 2016.

The headline index from the Commonwealth Bank Manufacturing Purchasing Managers’ Index (PMI) eased to 52.0 in March, down from 52.9 in February – marking the lowest figure in 32 months and indicating only a modest improvement in the health of the manufacturing sector.

Weighing on the index was a combination of more slowly expanding output, as well as lower employment.

The reports will be followed on Wednesday by an update from the Housing Industry Association on new home sales.

Wednesday, May 1

• HIA New Home Sales

Then, in the latter part of the week, market participants will receive further color about Australia’s business service activity, as well as an update on CommBank’s Australia Composite PMI.

Thursday, May 2

• Ai Group Services Index (Apr)
• CBA Services PMI – Final (Apr)
• CBA Composite PMI – Final (Apr)

Early data released by CBA earlier in April showed a modest return to growth for the Australian private sector.

The Australian manufacturing and services sectors both resided in expansion territory for the first time since January, with the latest “flash” CBA Composite PMI indicating a small uptick in business activity in April, aided by modest growth in the services sector.

CBA economist Gareth Aird said that while the result was “soft,” it was “an improvement nonetheless.”

In April, the headline index rose to 50.6, up from 49.5 in March.

According to CBA, although the sectors appear to be sending positive signals on the outlook for the economy, reported shortages of new work have led to modest reductions in staffing levels for the first time in the survey’s three-year history.

Aird added that the “main concern for us in the data was the employment sub-components of both the manufacturing and services PMIs. Both readings moved lower and sit in contractionary territory.”

Australian stocks remain supported

Elsewhere, the softness in Australia’s economy does not appear to have had a detrimental impact on its equity market, amid accommodative monetary policies across several central banks, including the Bank of Japan, the European Central Bank, and the U.S. Federal Reserve. Recent stimulus measures from China also seem to have helped prop-up that country’s economic health somewhat, with potential positive effects for trading partners such as Australia.

Australian equities – as evidenced by the iShares MSCI Australia ETF (NYSEARCA: EWA), which has among its top holdings several financial sector firms such as CBA (OTCMKTS: CMWAY), Westpac Banking Corp (NYSE: WBK) Australia And New Zealand Banking (OTCMKTS: ANZBY) and National Australia Bank (OTCMKTS: NABZY) – have climbed roughly 18.54% from their most recent 52-week low set December 24, 2018, nearly erasing its more than 20.5% plunge in the second half of 2018.

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Investors will likely be eyeing further developments in Australia’s manufacturing sector and housing market, as well as domestic factors that have been stunting growth, including household consumption.

Market participants will also likely be paying close attention to global uncertainties, such as the unfolding of U.S.-China trade talks, Brexit and oil prices for additional insights into the country’s general economic and financial well-being.  

In the meantime, select the Event Calendar option in the IBKR Trader Workstation for a full list of the U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more.