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Last night’s decision by the RBA to lower the cash rate by 50bp to 3.75% ought to be applauded. Faced with an economy which, outside the mining sector, is in recession and with inflation likely to be lower than expected, policy-makers rightly decided that financial conditions needed to be loosened considerably.

Australia’s central bank would also be concerned by the continued decline in property prices – according to the ABS, established house prices fell by a further 1.1% in the first quarter, the fifth consecutive quarterly decline. More rate cuts are likely to be in the pipeline, judging by the level of term interest rates and the shape of the yield curve. For shorter-term maturities, yields fell by as much as 20bp overnight with the 2yr yield now just 2.8%! Both 5yr and 10yr bond yields fell to record lows.

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The RBA will also be pleased by the response of the currency, with the Aussie down 1% to just above 1.03. Last night’s sudden drop aside, it is worth recognising that the AUD’s recent performance has actually been remarkably resilient considering the significant narrowing in interest rate differentials. As we were suggesting yesterday, the key driver for the currency is invariably global risk appetite rather than domestic fundamentals.

Commentary

Gold’s fall from grace. A more defensive tone was apparent on Monday, with risk assets losing ground. Safe-haven currencies such as the dollar and the Japanese yen were in favour, while high-beta currencies such as the Aussie fell back. The Canadian dollar, one of the forex market’s real darlings of late, fell back noticeably after much weaker than expected GDP figures for February. In relative terms the pound fared rather well once again – cable reached 1.63 at one stage, while EUR/GBP fell to nearly a two year low. The single currency was under pressure for most of the day – the news out of Spain continues to worsen, with the economy back in recession and bank deposits continuing to flow out at a rapid rate. There was talk that some sovereign wealth funds were on the offer as well. Interestingly, the gold price fell sharply early in the London afternoon, to below USD 1,650 an ounce. These days gold is just not performing during those periods when safe havens are sought after.

Brussels responds to Hollande’s growth demands. Stung into action by mounting criticism that Europe needs a growth plan alongside the current unflinching commitment to perpetual fiscal austerity, Brussels appears to be mounting a counter-offensive. According to a report in the Spanish daily El Pais over the weekend, the European Commission is considering a proposal to attract EUR 200bn of public and (mainly) private money into infrastructure, renewable energy and high-end technology. Apparently some EUR 12bn of capital would be provided to the European Investment Bank (EIB) by the EFSM, which would in turn be used as guarantees for bonds issued by the former aimed at pension funds and high net worth investors. The hope is to raise EUR 200bn in this way. Last week there were some whispers around such a plan, and it certainly has merit. In response, French Presidential hopeful Francois Hollande claimed on Monday that his growth agenda was now being heard right across Europe. That may be so, but the danger for him from a political perspective is that it dilutes his message just days before the crucial second round of voting. All of the polls still have him as the firm favourite. If he does win the election, especially if it is a resounding victory, then both the single currency and peripheral bond markets would likely be unimpressed by his commitment to renegotiate the fiscal compact.

Eurobills proposal gains traction. A proposal to permit the sale of eurobills is gaining some traction in policy circles. Last week, Olivier Blanchard, the IMF’s Chief Economist, claimed eurobills represented a “very good first step” towards the issue of Eurobonds and that they would entail very little credit risk to European nations. An additional constraint is that no euro nation would be allowed to have eurobills on issue greater than 10% of their nominal GDP. Germany remains implacably opposed to any suggestion of eurobonds, with Merkel frequently arguing last year that it was akin to putting the cart before the horse. That said, now that Merkel has her fiscal compact, she may be more amenable. For its part, France is in favour. Also, eurobills would provide banks with a very safe asset which would help them to meet demanding capital requirements.

Spain’s recession likely to intensify. There was confirmation on Monday that Spain is officially back in recession, with GDP declining by 0.3% in Q1 after a 0.4% fall in the previous quarter. Spain is the latest member of a growing list of European economies now in recession, including the UK, Netherlands, Belgium, Ireland, Greece, Portugal, Italy, Denmark, the Czech Republic and Slovenia. Undoubtedly, it is likely to get worse before it gets better in Spain.

 

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