An August rate cut? Markets say yes

Immediate reaction to poor Chinese manufacturing data and Australia's inflation point to an imminent rate cut,

Fickle they may be, but the betting on currency markets overwhelmingly is in favour of an interest rate cut at the next Reserve Bank Board meeting.

Of the two key data releases this morning, China’s industrial production numbers dominated sentiment.

The HSBC flash numbers on China’s industrial production for June came in well below expectations at an 11 month low of 47.7.

Not only is that contractionary, it represents a further slide from the previous weak read of 48.2.

Given the strong rise in iron ore prices in the past month, there had been speculation today's numbers would show signs of a lift in China’s economy (see Annette Beacher's If China is slowing, why won't iron price fall?). But it appears much of the improved demand for raw materials follows an extended period when Chinese steel mills ran down stock levels.

That took the wind out of the local stocks which, while still in positive territory in the lead up to the lunch break, gave up half the gains of earlier in the session. The Australian dollar, after soaring briefly on the inflation numbers, fell sharply to US92.65c immediately after the Chinese data hit the screens.

Australia’s June quarter inflation numbers were benign with a seasonally adjusted 0.5% in June that came in at an annualised 2.4%.

That gives the RBA ample space to cut rates in a fortnight if it needs, given it slightly below the mid-range of its comfort zone of between 2 and 3%. But it is slightly higher than the RBA’s inflation forecast of 2.25% making for a potentially vigorous debate around the RBA board table in August.

Business confidence remains subdued and consumer spending has been restrained despite 20 months and more than 200 basis points of rate cuts, adding weight to calls for an imminent cut.

In addition, the RBA's most recent minutes suggested it thought China's growth outlook was stable. It would appear from recent events that China's growth is still slowing and that commodity prices may again come under pressure in the near future

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