MACQUARIE: Two rate cuts are coming, maybe more

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While an increasing number of analysts are now optimistic towards the outlook for the Australian economy, that sentiment is not shared by all in financial markets.

James McIntyre, an analyst at Macquarie Securities, thinks Australian economic growth will struggle this year, suggesting that it “is likely to weaken as the economy digests the last half of the decline in mining investment spending and the hit to income from lower commodity prices”.

He believes that rather than accelerating on from the robust 3.0% level seen in the 12 months to December 2015, the “muddle through” for the economy will likely continue in the year ahead.

“Economic growth rests on two foundations, resource exports, and population growth,” says McIntyre. “Without these, the economy would be struggling to grow.”

“Our revised growth outlook reflects the disappointing non-mining business investment outlook revealed in the recent capex survey. We expect recent GDP strength, which reflects dissaving and a build in inventories, to fade through 2016, with the cyclical recovery in the economy delayed until 2017.”

The chart below, from Macquarie, reveals how the bank’s forecasts for economic growth this year differ substantially from those offered by the RBA.

Given the forecast steep deceleration in the outlook for economic growth, McIntyre believes there’s still work for the RBA to do when it comes to monetary policy. While acknowledging last week’s solid jobs report for March has diminished the likelihood of a rate cut from the RBA in May, McIntyre believes the RBA will have to cut the cash rate to 1.50% this year – with risks to the call slanted to the downside, not upside.

In other words, they may need to go further than 1.5%.

“A May cut is still a live risk, given the upcoming CPI. However, the given the labour market outcome we think that the balance of risks lies with a later, August cut,” says McIntyre. “Our low point for the current rates cycle remains 1.50%, but we acknowledge that the risk that further easing has risen.”

Yes, Macquarie sees the risk that interest rates could fall below 1.50% at some point later in the year, a very bold call given the vast majority of economists and interest rate traders see none, or perhaps one, rate cut over the course of this year.

Beyond 2016, McIntyre also forecasts that monetary policy normalisation from the RBA — the beginning of the next rate hiking cycle — will likely be delayed to first half of 2018.

“We now expect the RBA will commence normalising (raising) rates in 1H18, compared to our previous expectation of 2H17,” he says. “Whilst we see the labour market beginning to tighten from 2H17, we think that the underlying inflation outlook will keep the RBA on hold until 2Q18.”

Here’s Macquarie’s forecast for the RBA cash rate in the years ahead, compared to current market pricing.

In a poll of 26 economists conducted by Bloomberg, the median forecast is for the RBA cash rate to sit at 2.0% by year’s end. Cash rate futures still price in the likelihood of one rate cut being delivered in the final quarter of the year.

Macquarie are joined by RBC Capital Markets, Morgan Stanley and Laminar Capital in calling for the cash rate to end 2016 at 1.50%.

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