Australian bonds gain on lower inflation expectations, RBA rate cuts on the cards

The Australian government bonds gained Thursday after data showed that Melbourne Institute’s (MI) inflation expectations weakened in August, while justifying the Reserve bank of Australia’s last week policy decision.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, fell 3 basis points to 1.853 percent and the yield on short-term 2-year note dipped 1 basis point to 1.445 percent by 05:20 GMT.

Australia’s MI recent survey showed that the consumer inflation expectations for August weakened to 3.5 percent, as compared to 3.7 percent in July.

The country’s inflation expectation has been trended lower for most of the year, mirrored broader trends in consumer inflation growth. On an annual basis, consumer inflation eased 1 percent y/y (it was the lowest annual rate since 1999), marginally lower than the economist consensus of 1.1 percent, from 1.3 percent during the same period a year ago.

On Wednesday, the Reserve Bank of Australia's outgoing Governor Stevens said that current inflation target regime has flexibility, but it is still useful and need the realism on what monetary policy can do, including pushing up inflation quickly.

He said the board is well aware of the risks of trying to push inflation to target in "short order" and undershooting inflation target with reasonable economic growth might be "least bad" option. He said monetary policy cannot simply dial up the economic growth that the country needs and it is hard for the monetary policy to revive demand when households are so indebted.

Furthermore, it remains a case for governments to borrow for investment assets that yield economic return and not to borrow to fund recurring spending. He finally said that the path to budget balance is turning out to be a very long one and many difficult choices are to be made in the near future.

In the question and answer session, he commented that he favours the current 2 to 3 percent inflation target band and remained cautious on lowering the target, while also maintaining economic growth near potential and unemployment between 5 to 6 percent.

He said globally it is difficult to implement negative rates without hurting banks' earnings and the chance of negative rates in Australia is very low. He expected mortgage rates would not fall by full 25 basis points last week and it is very unlikely that the Australia would be so desperate to consider helicopter money.

Lastly, markets will remain keen to focus on the next week’s employment data. Meanwhile, the benchmark Australia's S&P/ASX 200 index traded 0.43 percent lower to 5,459.5 by 05:20 GMT.