Tim Toohey, chief economist at Goldman Sachs in Australia, believes the RBA is going to be “dragged into a deeper easing cycle” after the convergence of a number of negative factors at the start of 2016.
Writing with economists Andrew Boak and Bill Zu, Toohey identifies 4 key drivers of his view that the RBA will cut rates by 0.25% in both May and July this year.
Here’s their justification for the new call from the note today:
A new round of central bank easing – including further moves into negative interest rate territory and the market’s diminished assessment of the prospect of further US Federal Reserve hikes – leaves Australia vulnerable to a higher exchange rate and tighter financial conditions should the RBA elect to leave interest rates unchanged. A sustained tightening in financial conditions has taken our FCI [financial conditions index – a measure of the true level of monetary tightness in an economy] to levels well above each of the four last interest rate reductions by the RBA. Our assessment that inflation will undershoot expectations in 1H16 and employment growth in 2015 could have been overstated by as much as half and will likely correct in coming months. The risk of an early Federal election in March or April remains, bringing with it the risk that another round of fiscal consolidation will be attempted post the election in the May Budget. As such the RBA may seek to accommodate the fiscal tightening.
That would leave the cash rate at 1.5% against the current RBA cash rate of 2%. 1.5% would be a new low for the RBA cash rate in the modern era. But it would still represent a significant pick up to other developed market cash rates, and by extension bond rates in other Triple-A rated nations.
That “search for yield” by offshore investors is, Toohey says, along with easing downward pressure from Australia’s terms of trade, increasing the chance of a rally in the Australian dollar. Such a rally could push the Aussie to 75 cents instead of Goldman’s six month target of 67 cents. That would represent a financial tightening for the economy and thus require an RBA response.
“In short we believe that financial conditions are too tight to expect the current pace of economic expansion to be sustained,” Toohey wrote.