Macquarie still thinks the RBA will cut twice this year

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If there was a talking point to come from the Reserve Bank of Australia’s (RBA) first rate meeting of the year, it was the cautiously optimistic tone throughout its February policy statement.

The bank suggested that the shock 0.5% GDP contraction in the September quarter last year was an aberration, largely driven by temporary factors, with “a return to reasonable growth” expected in the December quarter.

It even sounded optimistic on the outlook for the economy, suggesting that growth would be helped by further increases in resource exports, less drag from declining mining investment, a pick-up in consumption and in non-mining business investment.

As a consequence, the RBA said that its “central scenario remains for economic growth to be around 3% over the next couple of years”.

Coupled with the view that inflationary pressures will slowly build, but little concern over the recent strength in the Australian dollar, the RBA suggested it remains very comfortable with where the economy currently sits, adding to the belief held by many analysts that interest rates are likely to remain on hold for the foreseeable future.

Indeed, an increasing number now think that rates could actually rise by the end of this year.

However, not everyone shares that view, including James McIntyre, an analyst at Macquarie Bank.

He’s calling for the RBA to cut rates twice this year, beginning as soon as May.

If correct, that would leave the cash rate at just 1%.

“We remain of the view that the RBA will be dragged into additional easing in 2017 — 25 basis points in May and August is our current base case — as the elevated currency dampens the non-mining transition,” he wrote on Tuesday.

This chart, supplied by Macquarie, shows its current cash rate forecasts compared to current market expectations.

Like many others, McIntyre picked up on the cautiously optimistic tone seen in the RBA’s February statement, noting that it “appears quite comfortable with rates on hold as a range of forces impacts the economy”.

However, McIntyre says there are several important data releases arriving in the week’s ahead that could easily see that comfort turn to concern.

“Whilst the consumer story looks to be on track, in 4Q16 at least, all eyes will be trained on the much anticipated pick-up in the non-mining business investment expected in FY17/18,” he says.

“The first estimate of firms’ capex plans for FY17/18 will be published in late February, ahead of the 4Q16 GDP data. Similar to past years, signs that non-mining investment is not stepping up could tip the balance in favour of rate cuts aimed at weakening the AUD.”

On inflation, something the RBA sees gradually returning towards it’s 2-3% target in the coming years, McIntyre says this expectation is clearly based on the economy continuing to grow, and the exchange rate not appreciating further than it already has.

While he, like the RBA, sees growth picking up in 2018 and 2019, McIntyre says that with the Australian dollar trade-weighted index currently sitting near-two year highs it will complicate the economy’s adjustment, making the outlook for inflation “challenging” for the RBA in 2017.

He is also cautious towards the recent lift in Australia’s key commodity prices, suggesting that while it has provided support to the Australian dollar, the “translation of the income gains from those commodity prices from national income, to domestic income, and subsequently through to domestic demand within the economy, is unlikely to be as swift or powerful as the experience of the early 2000s commodity price rise”.

While financial markets are now starting to price in the likelihood that rates may increase by the end of this year, McIntyre is not alone in calling for two rate cuts to be delivered this year.

In a survey of 25 economists conducted by Bloomberg on February 3, five other groups — including the National Australia Bank and Morgan Stanley — saw the cash rate sitting at 1% by the end of the year.

At the other end of the spectrum, TD Securities is the sole group who thinks that the cash rate will sit higher, calling for a 25 basis point hike in final quarter of the year.

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