AUD/USD

Australia's economy slowed more than expected last quarter as consumers reacted to tepid wage growth by shutting their wallets, a disappointing outcome that sent the local dollar sliding as investors pushed out the chance of any rate hike.

Futures are now implying only a 20% probability of a hike by Christmas next year, down from 40% earlier this week.

Wednesday's GDP report showed Australia's economy expanded 0.3% in the third quarter, half of what the market had expected.

Annual GDP rose by a still-respectable 2.8%, but confounded expectations for a 3.3% increase.

The figures imply growth in the year to June was 3%, rather than the originally reported 3.4%.

The data will not be welcomed by the Reserve Bank of Australia (RBA), which predicts growth of around 3-1/2% this year and next.

Australia's economy has generally outperformed its rich world peers in recent years and is in its 28th year of growth without a recession. But while the RBA has maintained its optimism, the market is increasingly getting bearish on future momentum as Australia's once-booming housing market hits the brakes, with potentially adverse effects on consumer wealth and spending.

A long stretch of unusually slow wages growth has also throttled household incomes.

Indeed, a major drag in Wednesday's report came from private consumption, which added a mere 0.2% to growth after 0.7% in the June quarter.

The GDP report showed that while employers were taking on a lot of new workers they weren't paying them much more, so average wages rose by just 0.2% in the quarter.

This soft underbelly of the economy is a major worry for the Reserve Bank of Australia.  Adding to the case for caution is the ongoing U.S. trade dispute with China, Australia's single most lucrative export market. Thus while the RBA is still tipping economic growth of 3.5% this year and next, it shows no inclination to tighten anytime soon.

Federal Reserve Vice Chairman for Supervision Randal Quarles said that interest rates are approaching neutral, but the concept of neutral rate can be less useful after the economic conditions become more normal.

Fed officials estimate the neutral rate of interest is from 2.5 to 3.5%, according to Quarles. Asked if Powell meant rate hikes would end sooner rather than later, Quarles said it was not clear about exactly how much further interest rates would rise.

"Where we will end up in that range will depend on the data we receive and our assessment of the performance of the economy over the course of next year," he noted.

Neutral interest rate, a notion that is driving the Federal Reserve' s attitude towards the normalization of U.S. monetary policy, means a level neither stimulative nor restrictive to the economy.

"I think that it can be a useful concept in helping guide monetary policy, but it's not terribly precise," Quarles said.

It may be changing over time, and "its utility as the central organizing thought around how you are conducting monetary policy becomes less."

"Because we are nearing other time where and we're moving back into a normalize monetary policy, that what's really important is that the Fed Reserve have a clearly communicated strategy, about monetary policy and that we execute on that strategy in a way that's predictable and transparent," said the Fed official.

The remarks came after Jerome Powell, chairman of the Fed, said last Wednesday that interest rates are "just below" the broad range of estimates of the level that would be neutral for the economy. Market participants interpreted that as a dovish signal for future rate hikes, compared with his previous remarks in early October that rates were "a long way" from neutral.

Fed raised its benchmark interest rate for the third time this year on September 26 and made the target range between 2% and 2.25%. At that time, Fed policymakers indicated another hike in December, three more in 2019 and probably one more in 2020.

In a widely expected decision, the Reserve Bank of Australia held its cash rate at 1.50% today and took an optimistic view on domestic activity.

"The Australian economy is performing well," RBA governor Philip Lowe said in a statement, while predicting a further fall in unemployment.

Yet as consumer prices remain subdued - a major reason for the RBA's steady stance in the past two years - policy makers have shown no urgency to tighten rates. Markets are not fully pricing in a rate rise until well into 2020.

"Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual," Lowe said.

He repeated the outlook for household consumption was a "continuing source of uncertainty" as incomes remained weak while debt levels were high.

The GDP report is due on Wednesday and is forecast to show growth of 0.6% in the September quarter from the June quarter when the economy expanded 0.9%. Annual growth was likely 3.3%, tracking a brisk 3.4% the previous quarter.

Lowe expects Australia's economy to expand at an annual 3.5% pace over this year and next, helped by solid business investment and strong public spending on infrastructure. His optimism was supported by stronger-than-expected data from the Australian Bureau of Statistics earlier in the day.

Figures showed government spending climbed 1.1% in the third quarter to an inflation-adjusted AUD 109.7 billion.

Public spending accounts for almost a quarter of annual GDP and has been a major driver of growth over the past year or so.

Separate figures showed net exports likely added around 0.4 percentage points to GDP growth last quarter, largely led by liquefied natural gas and tourism. That helped shrink Australia's current account deficit to AUD 10.7 billion.

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