While most economists now believe the Reserve Bank of Australia will leave interest rates unchanged for the foreseeable future following today’s rate cut, financial markets still think another reduction is coming.
As shown in the chart below, supplied by the Commonwealth Bank’s interest rate strategy team, overnight index swaps are now fully priced for another rate cut — taking the cash rate to 1.25% — by May next year.
In the collective minds of interest rate traders, it’s not a case of “if” the RBA will cut rates again, but when.
The red line shows where markets expected the cash rate to bottom prior to today’s decision, with the blue line reflective of the change in market pricing following today’s announcement.
Whereas markets were speculating about the potential for two rate cuts before the RBA meeting, they now see two cuts — the one today and another in the future — as a given.
According to Jarrod Kerr, senior interest rate strategist at the Commonwealth Bank, the current market pricing is justified.
“The subdued domestic inflation outlook provides the RBA’s reason to stimulate,” says Kerr. “But a rise in bank funding costs, weak international inflation outlook, and the RBA’s growing comfort in lending practices all point to another rate cut in November. We forecast a move to 1.25% by year end.”
Beyond this year, Kerr suggests that the risk are still towards rates falling to 1.0% in 2017.
While such an outcome may seem fanciful to some in financial markets, it wasn’t too long ago that a sub-3% cash rate was seen as unlikely. Indeed, up until April 27 this year, the vast majority of economists believed that the cash rate would remain at 2% before rising, not falling, in late 2017.
Adding credence to his view, Kerr was only one of a handful of analysts who were calling for lower rates earlier in the year.
That track record, along with recent events, suggest there could well be more rate cuts to come in the period ahead.