Back on April 26, the day before the release of Australia’s March quarter consumer price inflation (CPI) report, a rate cut from the Reserve Bank of Australia (RBA) this year, let alone a week later, was seen as highly unlikely.
The vast majority of economists saw the next move in Australian interest rates as higher – albeit not until well into 2017 – while interest rate markets were evenly split as to whether or not one additional rate cut would be delivered this year.
Headline CPI fell during the quarter, indicating deflation, while core inflation rose by just 0.15%, leaving the annual increase at 1.55%. Both core readings — whether quarterly or annual — were the lowest levels seen since at least 1983.
That’s more than a generation ago.
The fallout from the report has been enormous, particularly in Australian financial markets.
The RBA cut interest rates for the first time in a year just six days later, taking the cash rate to a record low level of 1.75%.
In the subsequent quarterly statement on monetary policy released three days after the rate decision, the RBA scaled back its inflation forecasts for the years ahead, predicting that core inflation was unlikely to move back into its 2-3% inflation target before mid-2018.
This, along with the rate cut, saw expectations for a further rate cut from the bank, perhaps as soon as June, surge. Most economists now see the RBA cutting interest rates to 1.50% in August, a wildly different view to that offered before the events of the past two weeks.
Like economists, financial markets have also reacted, as demonstrated in this excellent chart from ANZ’s interest rate strategist Katie Hill that she posted on Twitter.
It shows the change in overnight index swaps (OIS) pricing from the day before Australia’s March quarter CPI report was released, April 26.
Without getting into the mechanics of how OIS pricing works, it essentially shows expectations for where the RBA cash rate will sit in the future.
As a consequence of the inflation report, rate cut and downgraded inflation forecasts from the RBA, OIS pricing has fallen by nearly 50 basis points — 0.5% — from where it sat prior to the inflation report.
Cash rate futures, similar to OIS pricing as they reflect market expectations on where Australian interest rates will sit in the future, currently put the odds of the cash rate sitting at 1.25% by November — indicating two further 0.25% rate cuts from the RBA, not one — at 25%.
That means that one further rate cut by November is currently seen as a certainty, with the only speculation now over whether there’ll be another cut after that.
It’s an been an incredible turnaround in such a short period of time, and one that looks set to create ramifications across Australian bonds, stocks and the Australian dollar for some time yet.
You can follow Katie on Twitter. Her handle is @katie_hill2.
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