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Australia doing fine but risks abound

Wednesday, September 05 07:31:46

Australia's economy enjoyed solid growth last quarter to again outpace its peers, but there was little time to celebrate as tumbling export prices and a slowdown in China argued for a cut in interest rates now to safeguard growth in the future. Government data today showed gross domestic product (GDP) rose 0.6 percent in the second quarter, moderating from the previous quarter when it jumped an exceptional 1.4 percent. That left GDP up a brisk 3.7 percent compared to the second quarter of 2011, with domestic demand showing a particularly strong rise of 5.9 percent.

But while the economy had momentum then, the future looks more difficult as falling prices for key exports such as iron ore drain incomes and cool the red-hot mining sector. "The second half is going to be much more challenging," said Stephen Walters, chief economist at JPMorgan. "You're not going to get the same sort of growth rate we have had." The Reserve Bank of Australia (RBA) on Tuesday left interest rates steady at 3.5 percent but highlighted the recent sharp price falls in resource exports and admitted to uncertainty about the outlook for China, Australia's biggest customer.

The more sombre tone has seen markets narrow the odds for a rate cut as soon as October, following easings in May and June. Interbank futures <0#YIB:> put a 64 percent probability on a move in October and are more than fully priced for a couple of cuts to 3.0 percent by Christmas. Overnight indexed swaps, which show where the market thinks the cash rate will be over time, put rates at 2.82 percent in 12 months. Yields on Australian 10-year bonds are down at 3.00 percent, so it is cheaper for the government to borrow for a decade than for banks to borrow overnight.

Muted domestic inflation does mean the RBA has plenty of room to cut rates, which at 3.5 percent are among the highest in the developed world. The mounting talk of an easing dragged the Australian dollar down to a six-week trough of $1.0197. A fall in the currency could actually comfort the central bank as its persistent strength has been at odds with the weakness in the country's commodity prices. Spot iron ore, Australia's single biggest export earner at more than A$60 billion a year, has tumbled by one-third since early July <.IO62-CNI=SI>. If sustained, that will eat into both miners' profits and government tax receipts. ( C) Reuters