Why Australia's next GDP report could see the RBA cut rates

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  • Financial markets remain fully priced for the RBA to cut Australia’s cash rate to 1.25% by early next year. There’s also a small risk of a second cut being priced in.
  • Westpac Bank last week became the first of Australia’s big four banks to forecast RBA rate cuts.
  • The RBA has nominated “a sustained increase in the unemployment rate” or a “lack of further progress towards the inflation objective” as two outcomes that could warrant rate cuts.
  • Nomura says given the linkages to unemployment and inflation, upcoming global and domestic economic growth figures could be an additional trigger for the RBA to cut rates.
  • Nomura still sees the cash rate remaining at 1.5% until at least the end of next year but admits “it would not take much for us to put rate cuts into our profile”.

Financial markets continue to bet that the next move in Australia’s cash rate will be down, not up. An increasing number of market economists now also share this view, including Westpac Bank who became the first of Australia’s big four bank’s to forecast rate cuts from the RBA last week.

While the RBA doesn’t share that view just yet, arguing merely that prospects for the next move in the cash rate are now “more evenly balanced” than last year, it has made it clear that “a sustained increase in the unemployment rate” or a “lack of further progress towards the inflation objective”, are two outcomes that could see it lower official interest rates again.

Its focus on the unemployment rate, in particular, has garnered plenty of attention, meaning any labour market indicators — especially leading indicators — have now seemingly taken on increased importance in terms of what happens next.

However, the unemployment rate is a lagging indicator, telling us what economic conditions were in the past rather than what they’ll likely be in the future.

That means any deterioration in Australian labour market conditions, should that eventuate, may not be seen in the data for several months, delaying any potential support for the economy from looser monetary policy settings.

Rather than focusing on upcoming unemployment and inflation readings as to garner what the RBA may do next, Andrew Ticehurst, Economist and Investment Strategist at Nomura, says it may not actually be a further deterioration in those figures that could see the RBA take action.

“We think it is growth data rather than inflation data,” he says.

“This could be in the form of another material leg-down in global or local growth or signs that the labour market could deteriorate.”

The growth picture

Nomura’s view makes sense given economic growth plays a key role in determining the outlook for both unemployment and inflation.

Most economists believe Australia’s trend growth rate — the level where inflation and unemployment is expected to remain steady — currently sits around 2.75% per annum.

Any undershoot on this level of growth ahead, if the trend estimate is correct, would likely see unemployment creep higher and place downward pressure on inflation, triggering the two outcomes nominated by the RBA that could warrant further policy support.

Given Australia’s Q4 GDP report won’t be released until March 6, Nomura is sticking to its view that Australia’s cash rate will remain unchanged at 1.5% until at least the end of 2020.

However, Ticehurst admits “it would not take much for us to put rate cuts into our profile” given recent trends in consumer-related and housing market data.

“Consumer spending data for Q4 look relatively soft and follows a weak Q3, and we are wary that any attempt to boost low levels of precautionary savings in a modest wage growth environment could sacrifice future consumer spending,” he says.

“We are also nervous that slower growth through the second half of the year could translate well into slower employment growth sometime this year, despite fairly favourable near-term business survey and vacancy data.

“Similarly, the modest acceleration in wage growth at a time of limited pricing power suggests we could also see either a hit to profits or renewed efforts to manage costs elsewhere, including via a potential slowing in the pace of hiring.

“With inflation now below target for a full two years further and dwelling prices now falling at a reasonable clip, financial stability concerns now likely tilt more in the direction of a cut than a hike.”

And if the RBA decides that further monetary policy support is warranted, Ticehurst says the bank will likely deliver multiple rate cuts rather than one.

“A single 25 basis point move would be unlikely to have a material impact, and we suspect local banks would not pass one 25 basis point cut on in full, arguing that higher funding costs are adding to their cost of funds,” he says.

“Two 25 basis point moves would be more likely than one.”

If the RBA does take action, Ticehurst says there’s no guarantee it will stick to the script of delivering rate cuts in months following Australia’s quarterly CPI report, nor have to flag a likely decrease ahead in its official communications given additional easing is already priced in.

“The RBA, in our view, has never been fussed about micro-managing market expectations and would likely judge that a rate cut which came as more of a surprise would have a bigger impact,” he says.

“This argument is likely reinforced by the fact that, with a cash rate of 1.5%, it has relatively limited cash rate ammunition and would hope to maximise its impact.”

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