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By HaleStewart February 3, 2015 8:14 am
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Why Did Australia Cut Rates 25 Basis Points?

            The Reserve Bank of Australia just lowered interest rates, offering the following justification:

In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank's assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.

            Australia’s overall rate of growth has been moderate since the end of the recession.

For several periods, the YOY growth rate was very strong, with rates of ~3% at the beginning of 2010 and ~4% at the beginning of 2012.  But for most other periods, growth has fluctuated between 2% and 2.5%.

            But as the bank noted, something is obviously weak, which is best expressed in the slow but steady increase in unemployment:

Since the beginning of 2012, the unemployment rate has consistently increased from 5% to 6.2%.  And the reason is an overall weak environment for both manufacturing and services.  Let’s start with a chart of the AIG Australian manufacturing index:

The blue line – which represents the headline number – has been printing below the 50 level for the better part of the last three years, indicating contraction.  The level has been fluctuating between the 45 and 50 level, which is hardly a massive drop in business.  But, it is still in a contractionary reading.  And the latest report showed that 4 of 7 sub-indexes were in contraction as were 5 of 8 sub-industries.

            The Australian service sector is not fairing any better:

Like the manufacturing section, this index has been printing below the 50 level for the better part of the last three years.  Also note the large drop in domestic demand as well.  In the latest report all the sub-indexes were showing a contraction as were 8 of 9 industries.

            In contrast, we have the construction sector, which was doing well until the last few readings:

Like most construction sectors, Australia’s was in a contraction for 2011-2012.  However, largely thanks to low rates and in influx of Asian investment, the industry rebounded in 2013 and 2014.  But the last few readings have shown this sector reverting back to contraction.

            While the RBA’s cut today may have caught some off-guard, it shouldn’t have.  The increasing unemployment and overall weak condition of both the service and manufacturing sector for the last few years should have informed analysts that all was not well.  Add to that Australia’s attempt to shift from an export economy dominated by raw materials to one more based on internal consumption, and you’ve all but guaranteed that rates would be going lower.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

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