Australia Joins Asia's Easy Money Stampede -- Barron's Asia

        By Isabella Zhong
        A surprising show of strength by the Australian dollar finally prodded the Reserve Bank of Australia into swinging the axe at interest rates.
        It was third time lucky for Australia's central bank, which slashed its target cash rate by 25 basis points to a record low 2% on Tuesday after disappointing markets by standing pat in March and April. What is likely to have spurred the RBA to action this time around was a defiant Australian dollar that had gained more than 4% against the greenback to breach the psychologically important USD0.80 level last month, defying the central bank's attempts to jawbone the currency lower to buoy an economy weighed down by depressed commodities prices.
        Unfortunately for RBA, the market's reaction to monetary policy moves Down Under was all back-to-front. Instead of the Australian dollar moving down, it spiked higher after the announcement from the central bank. And what should have been a positive announcement for stocks was instead greeted by the S&P/ASX200 Index ending the day in negative territory and leaving investors wondering if the benchmark will ever break through the important 6,000 point level that has proved a solid barrier over the past two months. The benchmark is up nearly 8% this year.
        Australia's economy is in its 24th consecutive year of growth but it is expected to do it tough in 2015 as the waning of the mining boom and slumping commodity prices weighs heavily on activity. Australia has long been viewed as a leveraged play on China's growth, so it not surprising that the slowest pace of growth in the world's second largest economy is being felt in the so-called 'quarry with a view' that profited handsomely from strong demand for commodities like iron ore and coal. The task of maintaining momentum is being made all the more difficult by the Abbott government's focus on closing the country's budget deficit via spending cuts, with an update on the country's finances due next Tuesday with the release of the federal budget.
        The RBA is trying to engineer a baton change from mining being the driver of growth to consumption and residential construction taking the lead. While governor Glenn Stevens noted "encouraging trends in household demand", many economists believe policy makers will have to pull the trigger with further cuts this year, a task made easier by inflation running below the central bank's target range of between 2% and 3%. However, there is a risk that easier money may elevate concerns about the pace of gains in property prices, especially in Sydney.
        BNP Paribas economist Mark Walton reckons there is "ample policy space" to reduce rates again. While retail sales and unemployment have been improving in recent months, weakness in capital expenditure by the resources sector and waning export growth, could threaten to dampen the upbeat mood. Walton says the positive data is unlikely to have changed the RBA's view that economic growth will remain sub-par for some time. The Australian economy is forecast to grow at an annual pace of 2% in 2015, which is quite some way off the 4% plus pace the economy enjoyed few years ago.
        The resources sector remains the thorn in the side of policy makers. There is pain everywhere as a combination of waning Chinese demand and too much supply has hammered prices for key commodities like iron ore. That has sapped growth in the mining states of Western Australia and Queensland and transferred the yoke of growth to the east coast states likes New South Wales and Victoria. Iron ore prices have declined more than 20% since the start of the year. The weakness in the key steel making ingredient, coupled with flat coal prices and recovery in the oil price, has led to a significant deterioration in Australia's terms of trade.
        There are some market strategists who believe the Australian dollar is set to lose ground despite surprising pop on Tuesday afternoon. "On a trade weighted index basis, the Australian dollar is overvalued by almost 10%," argues Nomura currency strategist Charles St-Arnaud. Currently trading at around USD0.79 against the greenback, the Australian dollar is also sitting well above the UD$0.75 level that the RBA's Stevens has indicated would be a fair value. "Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices," the RBA wrote in its monetary policy statement. Nomura's St-Arnaud sees fair value for the Australian dollar at 0.72 against the greenback.
        The easier monetary policy is expected to help lift Australia's stock market which has been quite resilient despite the challenges confronted by index heavyweights BHP Billiton and Rio Tinto. While analysts believe the S&P/ASX200 Index will break through the 6,000 mark from current levels around 5,816 points level, foreign investors may struggle to make the case for investing in Australian stocks.
        Despite the technical support from lower interest rates, the flattish earnings outlook for the broader market looks lackluster against the prospect of 6% for the rest of the Asia-Pacific region. Additionally, valuations are markedly more expensive than those of other markets. Shane Oliver, head of investment strategy at AMP argues: "While Australian shares should do okay this year, better opportunities still lie abroad where the slump in commodity prices is not a drag on growth but rather a positive." According to Oliver, Australian shares are trading at 16.7 times projected earnings, which is above the 14.2 times they have averaged since 1992.
        Investors having been paying close attention to the bank reporting season that kicked off this week. Australia's big four banks - ANZ ( ANZ.AU ), Commonwealth Bank of Australia ( CBA.AU ), National Bank of Australia ( NAB.AU ) and Westpac ( WBC.AU ) - could benefit from lower interest rates, which are expected to give a boost to demand for loans. However, the lenders have seen their share prices plummet over the past week on potential tightening of lending rules by Australia's banking regulator. The tougher rules could reduce earnings for banks and has already led to a number of analysts downgrading their earnings and rating for Westpac, which reported earlier this week.
        Comments? E-mail us at asiaeditors@barrons.com
        (END) Dow Jones Newswires

        May 05, 2015 06:06 ET (10:06 GMT)

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