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Australia goes on the defensive with record-low interest rate

Lower home prices and consumption, along with China risk, threaten growth streak

"For Sale" signs dot properties around the Sydney area as housing prices slumped in 2018. (Photo by Fumi Matsumoto)

SYDNEY -- Australia's central bank has reduced a key interest rate to an all-time low, looking to counteract headwinds that put the country's unprecedented run of economic growth at risk.

The Reserve Bank of Australia on Tuesday lowered the policy rate by 25 basis points to 1.25%, the first rate cut since August 2016.

A lengthy period of slow income growth and the decline in Australian home prices are hampering the outlook for household consumption, Reserve Bank Gov. Philip Lowe said in a statement. The rate cut "will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target," Lowe added.

Yet some in the market expect the Reserve Bank to lower the rate again in August and November to promote employment further. The rate could hit 0.75%, said Bill Evans, chief economist at Australian banking group Westpac.

Australia has gone more than 27 years through December 2018 without a recession -- a contraction in gross domestic product for two consecutive quarters -- extending the record for a developed economy. However, the economy faces uncertainty from weaker housing prices.

In Sydney's eastern suburbs, a conspicuous number of houses carry "for sale" signs. Property values have been on the decline for about two years, said Nick Papas, a real estate broker in the area.

Market rates had traced an ascent from historic lows recorded around 2013 until reversing course last year. In a bid to curb the housing bubble, Australia's government pushed lenders to put mortgage applications under stricter scrutiny. China's restrictions against capital outflows also have slowed the housing market here.

The official housing price index for Sydney fell 7.8% on the year during the October-December period, a fourth straight quarter of decline for Australia's largest city.

Australian rate cuts that began at the end of 2011 succeeded in stimulating housing purchases, but also lifted household debt. The liability grew to 121% of GDP in 2017, according to the Bank for International Settlements. By comparison, household debt totals 77.8% of GDP in the U.S. and 57.2% in Japan.

Declining home values have cooled private consumption. Household spending accounts for 60% of Australia's GDP, and seasonally adjusted retail sales in the January-March period shrank 0.1% from the previous quarter. The consumer price index for the first quarter of 2019 rose only 1.3% compared with the year-earlier period.

The unemployment rate inched up to 5.2% in April from 4.9% in February. The central bank predicts the jobless rate will hover around 5% through the end of next year.

China's slowing economy also represents a major concern, considering the trading partner takes in 30% of Australian exports. The U.S. trade war with Beijing factors into the equation. Though the global economic outlook remains reasonable, "the downside risks stemming from the trade disputes have increased," Lowe said.

Australia's biggest export staple, iron ore, is directly exposed to China's slowdown. The ore is fetching around $100 per ton, approximately a five-year high, but Chinese demand looks to weaken amid the country's saturation of infrastructure and housing as well as a shrinking labor force, said Morningstar analyst Matthew Hodge, echoing a widely held opinion.

Hodge forecasts iron ore prices falling to $65 a ton in 2020, and all the way to $40 in 2022.

Coal, Australia's second-biggest export, carries its own trade risks concerning China. Last year, Canberra decided to block Chinese supplier Huawei Technologies from its 5G communications market. This year, some Australian coal has languished at Chinese ports due to customs delays, reports indicate. Some view this activity as retaliation for Huawei.

Australia's slowing productivity likewise has set off alarm bells. During the fiscal year ended in June 2018, productivity climbed 0.4%, the country's Productivity Commission reported Tuesday, weaker than the 1.3% growth logged in the previous year. Productivity in the mining industry declined 0.5%, compared with a 4.6% rise a year earlier.

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