Wednesday, March 16, 2011

Expecting a rate hike this year? The market is expecting a cut:

If you take the curve literally

The Japan crisis has put paid to talk of a further interest rate rise in Australia with the futures market now pricing in a zero chance of a rate hike in the year ahead and on a literal reading a better than even chance of a rate cut next month.

As a further two explosions at the Fukushima Daiichi nuclear power station wiped 10 per cent off the value of Japanese shares Australian investors bought bonds and bank bills pushing down yields to the point where the market factored in a 55 per cent chance of an April rate cut.

"Markets move quickly at times like this and quite often over react," said HSBC Australia economist Paul Bloxham. "The pricing doesn't make sense. Even with a global shock the outlook for investment in Australia is still strong. I do not expect the Reserve Bank to cut rates."

The Bank's cash rate has been 4.75 per cent since November. Board minutes released yesterday show two weeks ago the members judged that level "to be appropriate" and left rates unchanged.

Until Tuesday's frenetic trading the market had been pricing in one more increase to 5 per cent by mid 2012. It is now pricing in a cash rate slightly lower than 4.75 per cent for March 2012 and every month in between...

"The price action was breathtaking in its speed and execution", said Credit Suisse consultant Sean Keane. "The market has put in place precautionary cover in case the Bank feels the need to suddenly cut rates. The expectation is the panic will be largely over by the end of the year, and at that point the Bank can move back to a hawkish position."

Japan is the second-biggest buyer of Australian commodities. A stalling in its economy would cut demand for Australian resources and ease pressures flowing from the boom. On the other hand increased demand for Australian natural gas to re-power Japan and iron ore and coking steel to rebuild its cities could intensify the boom.

Separately released figures show lending down down across the board in Australia in January with the value of personal finance down a seasonally-adjusted 9.5 per cent, commercial finance down 5.8 per cent and housing finance for owner occupation down 4.6 per cent.

Published in today's SMH and Age

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