With the Bank of Canada's surprise rate cut on Wednesday, the odds have further increased that the Reserve Bank of Australia will soon follow suit.
While most economists had expected the Bank of Canada (BoC) to maintain a dovish stance on monetary policy through words rather than actions, the central bank shocked the financial world this week by lowering its benchmark overnight rate by a quarter point, to 0.75%.
Prior to that, the BoC's short-term rate had been stuck at 1% since late 2010, the longest such pause in the central bank's history. The central bank kept rates low to help the export sector take over leadership of the country's economy from debt-burdened consumers.
And in recent months, there's been increasing evidence that this long-awaited transition is finally underway. But while the BoC has been hoping that the country's beleaguered manufacturing sector would pick up steam on the export front, it's important to remember that energy products are Canada's top export category, accounting for about a quarter of the country's exports by value.
So crude oil's collapse finally forced the BoC to take action. The central bank believes a rate cut is a necessary insurance policy against a sharp drop in energy sector investment.
Although Canada's resource space accounted for 8.1% of gross domestic product (GDP) in 2013, according to Statistics Canada, the sector is estimated to have been responsible for as much as 35% of private non-residential investment. Many of the country's energy exploration and production companies have already announced dramatic cuts to 2015 capital budgets.
Similarly, Australia is enduring a decline in mining investment now that the resource boom is over. And iron ore, which accounted for about 22.6% of Australia's exports by value in 2013 and is by far the country's top export, has suffered a decline equivalent in magnitude to that of oil.
Still, it's worth noting that Australia's export sector contributes markedly less to the country's GDP than Canada's exports do to its own GDP. According to the World Bank, exports account for about 30% of Canada's GDP, while Australia derives just 20% of GDP from its export sector.
Of course, GDP can't fully account for the way money earned in one area flows through the rest of the economy, so while these figures provide some context, they paint only a partial picture, at best.
Like the BoC, the Reserve Bank of Australia (RBA) has kept short-term rates low, in this case at an all-time low of 2.5%, to help the country's economy find growth from its non-mining sectors.
Just as in Canada, Australia's housing market was the first beneficiary of historically low rates, and both countries have their own housing bubbles with which to contend. Like Canada, Australia's economy began to show progress recently in its rotation away from the resource sector, with investment by non-resource firms growing by 5.5% in the third quarter versus a 3.5% drop in the mining sector, according to government data.
Both central banks have also hoped low rates and a dovish stance would undercut their exchange rates, which have been rapidly falling over the past year-and-a-half following a period of unusual relative strength. A lower exchange rate can help boost a country's exports by making prices more competitive when translated into foreign currencies.
A significant portion of the decline in each country's exchange rate has been driven by the U.S. Federal Reserve's hawkish stance on monetary policy. With the BoC's monetary policy now clearly headed in the opposite direction of the Fed, traders are increasingly betting on further easing from the RBA.
First, the Australian dollar quickly dived following news of the BoC's rate cut, and then dropped even further when the European Central Bank (ECB) made its own big move on Thursday, with the announcement of an EUR1.1 trillion bond-buying program.
In March, the ECB plans to start buying EUR60 billion of bonds each month, with hopes of bringing down long-term interest rates to stave off deflationary pressures and stimulate the Continent's moribund economy.
The aussie has fallen by 2.5 cents since Tuesday, which is a sizable move in the world of currencies. It currently trades near USD0.792, its lowest level since the Global Financial Crisis.
And while a clear majority of traders still expect the RBA to leave rates unchanged at its February meeting, futures data aggregated by Bloomberg suggest a still-substantial 32.3% probability of a cut. Meanwhile, the probability of a rate cut of at least a quarter point occurring at the March meeting has jumped to 65.4% from 40.6% a week ago.
As Westpac chief economist Bill Evans told The Sydney Morning Herald, "What we're seeing is a lot of central banks are making surprise decisions at the moment--Canada, India, Denmark. So in this environment of central banks pushing rates down and adopting easing strategies, it becomes a lot more respectable to do that."
This article originally appeared in the Down Under Digest column. Never miss an issue. Sign up to receive Down Under Digest by email.
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