Global turmoil behind interest rate pause

Reserve Bank of Australia Governor Glenn Stevens. Photo / Getty Images

Australia's central bank decided to extend a pause on interest rates because of concern that turmoil on financial markets could slow global growth, minutes of its August 2 meeting showed.

"The case against tightening at this meeting was that the downside risks to demand had probably increased, as a result of the acute uncertainty in global financial markets," the minutes released yesterday by the Reserve Bank of Australia showed.

"This, in turn, could weaken the outlook for demand relative to the central forecast and, over the medium term, dampen the inflation outlook."

Since RBA Governor Glenn Stevens kept the overnight cash rate target unchanged at 4.75 per cent for an eighth straight meeting, investor confidence has slumped after Standard & Poor's cut the United States' credit rating and as Europe's debt crisis deepened.

That sparked speculation the global recovery would weaken, driving down Australian consumer confidence and prompting traders to bet the RBA's next move would be to cut borrowing costs. "Significantly, the downside risks had become more pronounced recently," policy makers said in the minutes, referring to prospects for the global economy.

The RBA's decision was taken a day after the US Congress finished legislation to raise the country's debt limit and avert a potential default. Three days after the RBA meeting, S&P lowered the US's credit rating to AA+ from AAA, a move that caused equity-market turmoil the following week.

Stevens will lower rates by at least 75 basis points by December, interbank cash-rate futures showed before the minutes were released. Since the August 2 meeting, government and private reports have shown weaker employment and consumer confidence.

Unemployment last month jumped for the first time since October, to 5.1 per cent, a report last week showed.

Consumer confidence deteriorated for a fourth straight month to the lowest level in more than two years and demand for mortgages grew at the slowest annual pace in June since 1977, separate reports showed.

"Employment growth had clearly slowed," policy makers said in the minutes. "The forward-looking indicators continued to point to moderate employment growth over the period ahead, although the staff's liaison with businesses indicated some caution in hiring plans."

The decision to keep the developed world's highest rates unchanged came a week after a Government report showed the RBA's two preferred measures of annual inflation accelerated to 2.7 per cent in the second quarter, compared with a gain of about 2.3 per cent in the first quarter.

The data helped push the Australian dollar to US$1.1081 on July 27, the strongest level since exchange controls were scrapped in 1983. It also prompted the RBA's board to consider tightening monetary policy, the minutes showed.

The central bank aims to keep underlying inflation in a 2 per cent to 3 per cent range on average.

"The argument for tightening further was that underlying inflation had started to pick up and the central projection in the staff forecasts envisaged it rising above the target range during the forecast period," policy makers said. "Members believed there were grounds for concern about the medium-term outlook for inflation."

In deciding to extend the pause, members noted that credit growth was "very subdued" by historical standards, asset prices had softened and the exchange rate was high.

"While various other factors were affecting these variables, taken together they suggested that financial conditions were already exerting a reasonable degree of restraint," according to the minutes.

Australian households are saving more as assets including stocks and houses decline in value. A 17 per cent rise in the dollar in the past year is hurting the manufacturing and tourism industries. Balancing that, the Government estimates mining investment will reach A$76 billion this fiscal year.

- Bloomberg