GOLDMAN: 2 reasons the RBA will continue to cut rates

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Westpac’s decision to increase its variable home loan interest rates yesterday, along with the risk of a severe drought gripping Australia in the years ahead, now makes it “highly likely” the RBA will cut interest rates in November, adding to the case for additional monetary policy easing in early 2016.

That’s the non-consensus view offered by Tim Toohey, Andrew Boak and Bill Zu, Goldman Sachs’ Australian economic team, who believe the combination of the two will force the RBA to reluctantly cut rates in the months ahead.

“The combination of preemptive independent interest rate hikes by the banking system and the emergence of a new and significant threat to Australia’s economic growth comes at a particularly uncomfortable time in Australia’s economic cycle,” they wrote in a research note yesterday.

“Economic growth remains well below the RBA’s downwardly revised measure of ‘potential’ and pressures are well contained. Moreover, declining commodity prices, weak income growth, sharp declines in investment expectations and a peaking in the contributions to economic growth from housing have long suggested that the risks to economic growth were skewed to the downside.”

Goldman believes “it is highly likely that the other three large Australian retail banks will all soon follow suit.”

They suggest that the decision could result in a significant decline in consumer confidence heading into the key Christmas/Boxing Day sales period for retailers, negatively impacting on overall household consumption.

Pointing to the chart below, Toohey, Boak and Zu suggest financial conditions are already at levels akin to when the RBA cut interest rates in February and May this year, with Westpac’s decision and the likelihood of similar moves by other Australian banks set to tighten financial conditions even further in the months ahead.

In combination with the prospect of looming drought conditions in Australia, something the trio note has knocked a median 20% off Australian farm production based on historic norms, they expect underlying economic growth to slow further into 2016.

They also forecast that the Australian economy will grow by just 2% next year, with risks skewed “to the downside.”

As a result, Goldman retains its view that the RBA will cut interest rates by 25 basis points at its November policy meeting. While they suggest an additional 25 basis point cut can’t be ruled out in December, they believe the RBA will likely wait until the March quarter next year before easing policy further, “most likely in March post the release of 4Q15 CPI”. Toohey, Boak and Zu suggest the low point for the cash rate will be 1.50%, a level it looks set to remain at until 2018.

Goldman’s view is at odds with most economists, along with financial markets. According to cash rate futures the odds of a 25 basis point rate cut from the RBA in November currently sits at just 31%.

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