Australian rates markets, along with economists, have been split on whether or not the RBA will cut official interest rates in May.
Courtesy of last Wednesday’s incredibly low core inflation print — something that revealed inflation rose by the least amount on record in the 12 months to March — a rate cut, seen by many as near-impossible before the inflation report was released, is now seen as more likely than not by financial markets.
Cash rate futures put the probability of a 25bps cut at more than 50%, slightly more than economists who, on balance, continue to favour an on-hold call from the RBA.
50/50, line ball or a toss of a coin — however you choose to describe it, come 2.30pm AEST Tuesday afternoon, the announcement is likely to generate significant financial market volatility rarely seen around recent RBA meetings.
While the rate decision will be the focus of initial attention by most in financial markets, there many more factors at play than just whether the bank cuts interest rates or not.
The tone of the statement, particularly the RBA’s rates bias found in the final paragraph, has the potential to be just as influential, perhaps even more, on the subsequent movements in the Australian dollar, rates markets and the ASX 200.
Like many across financial markets, analysts at TD Securities have been busy pondering what the RBA is likely do, suggesting in a research note released on Monday that there’s a 60% probability that the RBA will leave rates unchanged.
“Our long held view has been that a low inflation print on its own would not be enough for the RBA to cut,” it said in a research note released on Monday.
“With H2 2015 annualised growth above long term average at 3% and the unemployment rate trending lower, there is no evidence the bank needs to cut rates ‘to lend support to demand’. The Bank needs more data/time to assess if the growth outlook is turning.
“This is why a RBA cut, if any, is a H2 2016 proposition.”
While it believes that the RBA will keep interest rates on hold — something that will initially place a rocket under the Australian dollar should it eventuate — TD suggests that the bank will “reaffirm its dovish rhetoric in tomorrow’s statement”.
This is “consistent with the significant downside underlying inflation miss versus the bank’s February forecasts, the subtle language change in the RBA’s March Statement where the Bank said ‘continued low inflation would provide scope for easier policy’ and the bank’s desire to contain the magnitude of an AUD rally on receipt of an on-hold rate decision”.
In an attempt to counteract the likely bounce in the Australian dollar should rates be left on hold, TD believes the RBA will likely reassert that an appreciating Australian dollar “could complicate the adjustment under way in the economy”.
It also suggests that a more aggressive easing bias from the RBA — pointing to the increased likelihood that interest rates could still fall further — may help take some of the heat out of the Aussie in the event that rates are left unchanged.
Here’s a guide from TD that looks at the expected market movements in the Australian dollar and domestic interest rate futures post the release of the RBA rate decision and monetary policy statement.
Interestingly, should the board cut rates to 1.75% come tomorrow afternoon, TD attaches a 100% probability that it will retain its easing bias, indicating the potential for a follow-up rate cut in the period ahead.