JP Morgan just pushed back its timeline for RBA rate cuts, but still sees the cash rate heading to 1%

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JP Morgan, one of only a handful of major forecasters still predicting rate cuts in Australia, now thinks it will take the RBA longer to deliver further monetary policy easing, pushing back its forecast for two further rate cuts — taking the cash rate to just 1% — until the first half of next year.

Previously is saw the RBA delivering those two rate cuts in the second half of this year.

In its opinion, rates are still going lower, it’s just going to take longer to happen.

Here’s Sally Auld, chief Australia economist at the bank, explaining the rationale behind the decision.

While we believe both recent developments — such as the macro-prudential regime — and the tone of recent data provide more support to the view that rates will be eventually cut to 1%, we think that the nature of the current economic adjustment is more sympathetic with RBA easing taking longer to occur. Moreover, in the wake of additional macro-prudential requirements, the RBA will probably take some time to gain comfort that efforts to slow growth in house prices and credit are sustainable.

In various research this year, we have highlighted that the current adjustment in the economy is proceeding through nominal, rather than real, channels. The labour market is a good example of this process; the adjustment is taking place via weak labour incomes growth and declining rates of growth in hours worked rather than through job losses and a rising unemployment rate. In a similar fashion, we have recently characterised the outlook for the Australian consumer as chronically soft, with minimal upside, rather than forecasting a sharp drop off in consumption growth.

While JP Morgan has pushed back the expected timing of when further rate cuts will be delivered, it’s holding firm with the view that they will go lower, leaving them in an increasingly small group who still expect this to happen.

The bank believes that rather than an economic shock triggering easing, the RBA will be forced to cut due to “an accumulation of modest disappointments” which it says will take some time to play out.

Here’s Auld on why JP Morgan still sees rates moving lower:

We think the fundamental justification for additional easing remains intact. We have long been of the view that the shock to Australia’s inflation trajectory in 1Q16 would ultimately require 75-100 basis points of easing in order to ensure first, stability in the core inflation trajectory, and second, an eventual return to target. The RBA have achieved the first objective (core inflation has been broadly stable at a 1.65% ar in recent quarters), but weaker growth outcomes and resiliency in the currency now mean that the second objective appears more distant. The current setting of overall financial conditions does not appear loose enough to generate growth in domestic demand that is consistent with achieving the inflation target.

So even with the cash rate sitting at a record low of just 1.5%, it’s still not enough to stimulate domestic demand, nor inflationary pressures, in her opinion.

And with the Australian dollar not helping to boost inflationary pressures or Australia’s international competitiveness, current settings are unlikely to deliver the expected boost to growth and inflation that the RBA sees in the year’s ahead.

JP Morgan says the risks to the timing of its rate cut forecasts are evenly balanced, noting that the RBA could cut both earlier and later than the first half of 2018.

“At some point in the second half of 2017 — either the August or November Statement on Monetary Policy — we think the RBA will have to acknowledge the impact of weaker growth outcomes in the first half of the year on its GDP and inflation forecasts,” says Auld.

“If a wholesale rethink of growth and inflation forecasts occurs as soon as August, then risks are biased towards an earlier start to the easing cycle, likely November.”

While most forecasters have the next move in rates being higher, not lower, Australian rates traders continue to price in a small probability of a rate cut being delivered within the next six months.

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