Australian bonds rally as lower inflation triggers RBA rate cut; 10-year yield hits record low

The Australian government bonds rallied on Monday as investors are pricing a 25 basis points rate cut from the Reserve Bank of Australia in the wake of subdued second-quarter inflation figure and sluggish economic growth.

Also, Bloomberg’s implied probability of 25 basis points rate cut by the RBA jumped to 66.8 percent, from last week’s 59.4 percent while the same increased to 70 percent for September monetary policy meeting, from previous calculation of 64.7 percent.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, fell 7 basis points to 1.835 percent and the yield on short-term 2-year note dipped 6-1/2 basis points to 1.474 percent by 05:00 GMT.

The Reserve Bank of Australia’s (RBA) August monetary policy meeting is scheduled to take place on August 2 at 04:30 GMT. We foresee that the central bank will lower its official cash rate (OCR) by 25 basis points to new record low of 1.50 percent, given that consumer inflation is expected to stay low for an extended period and since the labour market has lost momentum this year. Also, we think that risks surrounding the Australian dollar will likely factor into the central bank decision.

Last week, Australia’s second quarter headline consumer price index (CPI) increased just 0.4 percent q/q, in line with expectations, as compared to negative 0.2 percent in the previous quarter. Also, core inflation rose 0.5 percent q/q, a bit higher than the consensus of 0.4 percent q/q, from 0.2% in the first quarter of 2016.

On an annual basis, it 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. However, core-CPI remained flat at 1.7 percent y/y, higher than the expectations of 1.5 percent y/y. This result was still well below the RBA's target range of 2-3 percent and keeps an interest rate cut next month firmly on the cards.

In terms of recent economic data release, Australia’s July Melbourne Institute inflation gauge fell 0.3 percent m/m, as compared to 0.6 percent in June and increased 1.0 percent y/y, but lower than previous 1.5 percent growth seen in June. Also, the institute's trimmed mean remained unchanged on month, while it rose 1.4 percent y/y.

Meanwhile, the benchmark Australia's S&P/ASX 200 index was also trading up 0.23 percent or 13 points at 5,547 by 05:20 GMT.