If we ever needed confirmation of just how strong the outlook for the Australian economy is, we had it last night with a surprise rate cut in China, the second in about a month, the expected cut by the European Central Bank and another round of spending by the Bank of England to help the country’s recession-hit economy. Remember, on Tuesday the Reserve Bank left its key interest rate unchained and gave no clues as to further rate movements, despite the market belief that we will get more rate cuts. In contrast to the rest of the developed world, Australia is still a haven of growth, with high yields and a currency in strong demand for those reasons.
The moves did little to reassure markets: shares and commodities fell after the announcement and the the euro dropped 1%. The Aussie dollar rose, then fell, as the US dollar was again in demand. US bond yields fell as investors concluded the moves were a sign of how precarious conditions were in Europe and Britain, and how the potential for a “hard landing” in China had risen sharply.
Sentiment will get another test tonight with the June employment and jobless data for the US to be released. Many analysts are expecting another weak performance, although some later indicators suggest there could be a surprise on the upside. But June sales figures from some of America’s biggest retailers were the weakest in three years, which has added to the gathering pessimism in the US.
But all these moves and forecasts again underline how Australia is an outlier in the global economy with growth stronger than many of our trading partners and the outlook at the moment more confident. That’s why the Reserve Bank sat on its key interest rate this week as a spate of economic data on retail sales, new car sales, lending and building approvals added to the belief that the domestic economy is much stronger than many analysts had thought. The combination of the RBA move and the data has seen the the prospects of future rate cuts taken off the agenda in Australia, unless Europe or China worsen, or the fiscal impasse in the US develops into a full-blown crisis later in the year.
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What the moves in China, and especially Britain and Europe tell us that central banks are acting to try to help economies being weakened by the ongoing eurozone crisis, which is cutting demand and output and pushing unemployment to record levels. The moves in Europe are not positive, they reflect the weakening level of activity in Britain and across the EU, and not just the recessed eurozone. The ECB’s 0.25% cut was expected.
What wasn’t expected was the cut in the deposit rate on money parked by banks at the ECB overnight to 0% from 0.25%, while the rate on its marginal lending facility was lowered to 1.5% from 1.75%. The cut in the deposit rate removes the incentive for banks to hold money at the ECB, which now hopes the lack of a return will force the banks to lend to business and others. The Danish Central Bank later cut its deposit rates to a negative 0.2%, meaning the Danes really don’t want any more “safe-haven” money.
The big surprise was the second cut in Chinese rates in a month. The Chinese central bank lowered its one-year yuan deposit rate 0.25% to 3% and its one-year lending rate by 0.31% to 6%. The rate cuts start today. The two cuts mean Chinese rates have been dropped 0.50%, a sign that the slowdown is stronger than previously believed.
The central bank moves saw the Aussie dollar rise further above $US1.03 in offshore trading, before it turned lower in the afternoon as investors reassessed the moves and realised that they were not “good” news, but a signal of weakening demand. The Chinese rate cut does carry with it a warning to Australia that our biggest export market is facing renewed pressures from a slowing level of activity, even though trade data for May showed iron ore exports to China holding up and exports to other countries still solid.
China’s rate cut came ahead of monthly, quarterly and half-year economic data due for release late next week. Second quarter GDP figures will be released today week. The June rate cut came ahead of some economic data for May (but not May consumer inflation, which eased to an annual 3%, while producer prices fell by an annual 1.7%). Ahead of the rate cut, China’s Shanghai Composite fell 1.2% to end the day only 0.2% above its lowest closing level since the start of January.
The central bank though warned the country’s banks that they should not lend money willy-nilly: the PBoC said in a separate statement that banks not to use looser credit conditions to fuel property speculation. It called on banks to “continue to suppress speculative investments in housing“.
China’s move came about the same time as the Bank of England confirmed it was boosting its asset purchase program by £50 billion. The BoE has bought £325 billion of government bonds to date, and the purchases announced on Thursday take this total to £375 billion. But it left its key interest rate steady at 0.5%. The British economy is now in a shallow recession after recording negative growth in the December and March quarters.
There was a sliver of good news with Ireland returning to international capital markets for the first time since September 2008 with the raising of half a billion euros of three-month notes at 1.8%, cheaper than the 2.4% Spain paid a week ago for similar short-term money. But that was more than outweighed by a surge in market yields on Spanish and Italian 10-year debt. The yield on 10-year Spanish bonds leapt 0.37% to 6.78%, the highest level since June 29 and again close to the 7% interest rate that economists see as unsustainable. Yields on Italian 10-year bonds, which had been falling, reversed course and rose 0.20% to 5.97%.
Comments by ECB head Mario Draghi refocused attention on the spluttering economies of the eurozone and the area’s very fragile financial system. He told a news conference after the rate cut was announced that there was “heightened uncertainty” in the eurozone and added that the risks continued to be on the downside, with a potential spill-over from financial markets to the real economy. Another weak jobs performance in the US will add to the gathering gloom about global growth. But the US Fed won’t make any more moves until after the November elections, so the American economy could drift for a few months yet.