Swaps Signaling Australia’s Stevens May Hike Rates

(Bloomberg)--For the first time in three years, Australia’s interest-rate swaps are signaling investors are concerned Reserve Bank Governor Glenn Stevens may raise borrowing costs earlier than is needed to curb inflation.

A Credit Suisse Group AG index of swaps shows there’s a one-in-five chance the RBA will raise the overnight cash rate to 5 percent from 4.75 percent at a meeting tomorrow. Another swaps gauge indicates the RBA will cut the developed world’s highest benchmark 0.18 percentage point in the next 12 months. The last such split was in July 2008, two months before the collapse of Lehman Brothers Holdings Inc.

The divergence reflects an economy where business and consumer confidence have dropped while annual inflation reached the fastest pace in three years, fueled by a mining boom that helped drive the currency to a record. Australian government bonds, second only to New Zealand among 20 developed markets tracked by Bank of America Merrill Lynch, rallied in July by the most in 11 months, on concerns the economy is faltering.

“Some see the glass as overflowing, some see it rapidly emptying and the retailers claim that they can’t see it at all,” said Sean Keane, an analyst in Auckland at financial advisory group Triple T Consulting and a former head of Asia- Pacific rates trading at Credit Suisse Group AG.

Stevens held interest rates last month to gauge inflation pressures amid concerns that Europe’s debt crisis may undermine global growth, according to minutes of the July 5 meeting published on July 19. Since then, the impasse on raising the U.S.’s $14.3 trillion debt ceiling has also roiled markets.


Inflation Target

The RBA’s two preferred measures of annual inflation accelerated to 2.7 percent in the second quarter, compared with a gain of about 2.3 percent in the first quarter. The central bank aims to keep underlying inflation in a range of 2 percent to 3 percent on average.
Economists are also divided on tomorrow’s outcome: One of Australia’s four major lenders, Australia & New Zealand Banking Group Ltd. (ANZ) forecast the first rate increase since November, while Westpac Banking Corp. (WBC) expected Stevens will hold, before cutting rates in December. Twenty-one of 25 economists surveyed July 29 expect the RBA will leave borrowing costs unchanged in August, with the remaining four predicting an increase. The rate decision “is a close call,” said Paul Bloxham, Sydney-based chief economist for HSBC Holdings Plc and a former RBA official. “We think rates need to rise but that next week presents significant risks. On balance, we expect the RBA to remain on hold.”


Bank Credit

A central bank report last week showed loans provided by Australian banks and finance companies fell in June for the first time since October 2009 as business credit contracted and housing lending grew the least in 27 years. A gauge of Australian manufacturing slumped to a two-year low in July as the currency and the highest borrowing costs in the developed world hurt demand at home and abroad, according to a report today from PricewaterhouseCoopers and the Australian Industry Group.

Households are closing their wallets as rising energy bills, falling home prices and global concerns sap confidence. Retail sales unexpectedly dropped in May, the second decline in three months. “We are currently in the midst of a boom and gloom economy,” Heather Ridout, chief executive officer of the manufacturing group, said today in a statement. “The difficulties facing manufacturing due to the high dollar and sluggish domestic demand intensified in July.”

Further clouding the outlook is a deadlock between Republican and Democratic lawmakers negotiating to raise the U.S. debt limit by Aug. 2 to avoid the threat of a default.


U.S. Gridlock

Traders are betting on a 6 percent chance of a reduction in borrowing costs by year end, December cash-rate futures showed at 9:41 a.m. today, down from a 100 percent chance on July 25.

The benchmark 10-year Australian government note fell today after reaching an 11-month low on July 29. The yield climbed six basis points, or 0.06 percentage point, to 4.86 percent, widening the premium over 10-year Treasuries to 204 basis points.
Australia’s bonds returned 6.7 percent this year, including reinvested interest, second only to New Zealand debt’s 6.8 percent advance, the Bank of America Merrill Lynch indexes show.


Westpac’s Call

Westpac on July 15 became the first among Australia’s four biggest lenders to predict a rate cut in December. The bank, with A$279 billion ($308 billion) in home loans outstanding, said in a statement that “interest rates are too high in Australia given the state of the non-mining sectors of the domestic economy.” It predicted the nation’s unemployment rate may rise as high as 5.75 percent next year from 4.9 percent. Australia is undergoing what Stevens calls a structural change -- a shift in productive capacity to more mining and construction industries while the stronger currency hurts exporters, education, tourism and manufacturing. Prime Minister Julia Gillard’s government estimates that mining investment will reach A$76 billion this fiscal year. Business investment surged 24 percent in the second quarter, led by liquefied natural gas projects, Deloitte Access Economics said in a July 28 report. Projects valued at A$357 billion were committed or in progress as of June 30, up A$70 billion from the previous three months.


Natural Gas

The same day, ConocoPhillips (COP), the third-largest U.S. oil company, and partner Origin Energy Ltd. (ORG) approved the first stage of a $20 billion LNG project in Australia.

The Australian dollar climbed to $1.1081 after the July 27 inflation report, the strongest level since exchange controls were scrapped in 1983. The Aussie, the world’s fifth-most traded currency, advanced 2.5 percent last month and traded at $1.1029 today in Sydney.
The day after the consumer prices index report, ANZ became the first of the nation’s four largest lenders to predict an increase in rates tomorrow.

Inflation has reached “an uncomfortably high starting point given the robust 2012 outlook,” ANZ chief economist Warren Hogan wrote in a July 28 report.

“A small upward adjustment to interest rates now could well save the Australian economy from a painful series of rate hikes in 2012,” he said.

Inflation expectations, which had been declining on concern European and U.S. debt crises will roil global markets, gained after last week’s consumer price data. The gap between yields on 10-year inflation-linked bonds and debt not indexed to consumer prices widened 13 basis points over the past week to 2.88 percentage points today. The gap represents the average annual inflation rate anticipated by investors over the bonds’ lifetime.

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

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Lunacy....However others on this forum have observed my misguided musings (expert skills) relating to Mr.Steven's before.