Not once but twice -- Morgan Stanley sees multiple RBA rate cuts ahead

The odds of a rate cut from the RBA in May are on a knife’s edge. A combination of strong employment numbers in the past two months, a slightly hotter-than-expected CPI print in Q1 and more recently a sharp rebound in the iron ore price have seen expectations for a rate cut diminish in recent days.

Markets now believe it’s a 50/50 chance that the RBA will cut the cash rate to 2.00% in May and beyond that around the same probability that rates will fall below 2.00% in the second half of the year.

This excellent chart from Morgan Stanley’s Asia Pacific Research team shows how rate cut expectations have been paired since the RBA last met on April 7 — a meeting where the RBA surprised the vast majority in markets by keeping the cash rate steady.

While market expectations have diminished, Morgan Stanley believes further rate cuts are coming. Not only do they believe the RBA will cut the cash rate to 2.00% in May but also by an additional 25bps in the September quarter — something that will take the cash rate to 1.75% if it eventuates.

The basis for their forecast can be found in a snippet from their note below:

In short, we see the inflation backdrop as benign and expect the RBA to cut the cash rate to 2.00% in May, despite futures pulling back to a 50/50 probability. We also retain our out of consensus view that the RBA will cut rates for a third time to 1.75% in 3Q15, with the widening gap between a resilient AUD and falling commodity prices more important than the apparently strong employment data, which we treat with caution. Indeed, the RBA Board may note with concern that the AUD/USD is almost back the levels it was trading before the surprise February cut, while iron ore prices have fallen 20% since then.

Morgan’s, as demonstrated in the chart below, believe this will mark the low point for the RBA’s current easing cycle before rates gradually rise after an extended period on hold.

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