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03/07 00:21

Australia Central Bank Cuts Rate as Economy Contracts (Update1)

By Victoria Batchelor

Sydney, March 7 (Bloomberg) -- Australia's central bank cut its key interest rate a quarter percentage point to 5.5 percent as a report showed the economy contracted for the first time since the 1991 recession.

The economy shrank a more-than-expected 0.6 percent in the fourth quarter, raising speculation it's already in recession and that the Reserve Bank of Australia will have to cut rates further. The Australian dollar slipped three-quarters of a U.S. cent to just above its record low, and bond yields dropped to 23-month lows.

``Recession is now possible, even probable,'' said Greg McKenna, a currency and interest-rate strategist at National Australia Bank Ltd. ``This opens up the way for even more easing'' of interest rates, starting in April.

A recession is defined as two successive quarters of economic contraction. The decline in gross domestic product is the first since the second quarter of 1991, ending more than nine years of expansion. Economists had expected GDP to be unchanged in the quarter, according to a Bloomberg News survey, with just five of 18 forecasting a drop.

The economic slump is likely to cause consumers to spend less and companies to sack staff. Economists said the unemployment rate may rise to 7.25 percent from 6.7 percent in January.

``We've actually seen drops in our business greater than 1991 (recession) and a lot of other people have, too,'' said Gerry Harvey, executive chairman of Harvey Norman Holdings Ltd., Australia's largest computer and furniture retailer.

Firms Shed Staff

``We've already put off staff in the last eight or nine months, bit by bit,'' he said in an interview. ``Sales have been dropping in a lot of stores.''

The central bank's reduction in the overnight cash target rate follows last month's half-point cut, making it the first back- to-back decrease in more than four years. The RBA's key rate now matches that of the U.S. Federal Reserve.

The bank's decision to cut rates was made at its board meeting yesterday and was announced today, two hours before the released of the GDP figures.

``Looking at the data, everyone's going to say the Reserve Bank missed an opportunity to squeeze through 50'' basis points cut today, said David Mozina, a strategist at Merrill Lynch & Co.

``Everyone's going to bring forward projections of easings,'' he said, adding Merrill Lynch expects the cash rate to be cut to 5 percent or 4.75 percent.

Dollar Near Record Low

The Australian dollar fell to 51.23 U.S. cents from 51.97 U.S. cents before the bank's rate cut. That's the weakest since it hit 50.71 U.S. cents Nov. 22, which was the lowest level since it began trading freely in 1983. It recently traded at 51.31 U.S. cents.

Ten-year bond yields fell 6 basis points to 5.19 percent, the lowest since April 1999.

The implied yield on the June 90-day bank bill futures contracts -- a barometer of interest rate expectations -- fell 12 basis points to 4.73 percent, signaling investors expect rates to be cut as much as three-quarters of a percentage point by mid- year.

The economy grew 2.1 percent in the fourth quarter from a year earlier, the lowest annual rate of growth since the first quarter of 1992.

The weak GDP report is also a blow for the Liberal-National coalition government, which faces an election this year. A poll today showed its popularity is at a record low.

``The fall in the December quarter GDP was a very disappointing result,'' said Treasurer Peter Costello.

An 8.3 percent drop in business investment and a 15.4 percent fall in spending on housing paced the decline in GDP.

``Although the Australian economy has one foot in a technical recession, we caution that the downturn in activity was concentrated in '' construction and investment, said Monica Fan, senior economist at J.P. Morgan Australia Ltd.

Fan expects ``a modest rebound in GDP growth this quarter, thus avoiding a recession.''

Economy `Weakened Markedly'

Explaining its rate cut, the central bank said the economy ``weakened markedly'' toward the end of last year and into this year. Declining employment and low business confidence may damp growth further, the RBA said, suggesting more rate cuts to come.

``We are going to see rates at lower levels -- around 4.75 percent or 5 percent -- sooner than we anticipated,'' said Adam Boyton, an economist at Deutsche Bank AG, who expects rates to be cut again next month.

Mortgage lenders were quick to react, lowering home loan costs for borrowers. Commonwealth Bank of Australia Ltd., National Australia Ltd., Westpac Banking Corp. and St.George Bank Ltd. cut their floating home mortgage rates by 0.25 percent, effective from next week. That will save homebuyers A$24 ($12) a month on a A$150,000 loan repaid over 25 years.

Job Market Concern

A raft of recent economic reports showed economic weakness.

Job advertisements in February fell 10 percent to the lowest level since September 1997. As well, building approvals dropped 3.7 percent in January, countering expectations they would rise 2 percent.

Lower rates may help companies, such as Smorgon Steel Group Ltd., the second-largest steelmaker, and PMP Ltd., Australia's largest printing company.

Last week, PMP Ltd. said first-half profit fell 45 percent because of higher borrowing costs, gasoline prices and the impact of the consumption tax introduced July last year. Smorgon said fiscal first-half profit slipped 78 percent as it was hurt by a slowdown in construction.

The central bank estimates annual inflation, excluding impact of goods and services tax, is running around 2 percent. That's at the bottom of the bank's target range of between 2 percent and 3 percent.

-- (M@rket.trends), March 07, 2001