Now almost everyone thinks the RBA will cut again

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Australia’s incredibly weak March quarter consumer price inflation (CPI) report continues to create shockwaves across Australian financial markets, nine days after its release.

The RBA cut rates to a record low level of 1.75% on Tuesday and has signalled that it expects core inflation to remain below target until at least the middle of next year according to forecasts offered in its quarterly statement on monetary policy, released today.

The statement, like the inflation report and RBA rate decision before it, has been market moving, seeing expectations for a follow up rate cut in the months ahead skyrocket as a consequence.

Cash rate futures put the odds of a 0.25% rate cut on June 7 at a one-in-three chance, with that extending to 79% by the time the RBA meets on August 2, just days after the June quarter CPI report is released.

While financial markets expected a rate cut, or at times two, since the beginning of 2016, weak inflation forecasts, along with the RBA’s cut to official interest rates this week, has seen the Australia’s economic community change its tune, with the vast majority now expecting an additional rate cut, perhaps as soon as June.

According to a survey of economists by Bloomberg, 17 of 23 now expect the RBA to deliver an additional 0.25% rate cut in August – a stark turnaround from expectations that rates would remain unchanged at 2.0%, which the vast majority believed only weeks ago.

One, RBC Capital Markets, even thinks that a further rate cut will arrive in June. Given the dovish inflation forecasts offered by the RBA today, it’s slightly surprising that others have joined them in this view.

Here are just some of the economist’s notes we’ve received in the wake of the RBA’s SOMP release.

Adam Donaldson, CBA Rates Strategy

Today’s SOMP shows that the RBA’s mid point inflation forecast does not have the trimmed mean getting back to 2% by the end of the forecast period. That forecast is built on assumptions that oil and the AUD hold steady and, critically, that the cash rate moves in line with market pricing. That means they’re already effectively incorporating another 25bp cut into those numbers, and yet still missing their target for the next two years.

We have been forecasting 1.5% cash for more than a year, partly on low inflation grounds. Today’s inflation forecast from the RBA says they’re going even lower, to at least 1.25% and quite possibly starting in June.

Bill Evans, Westpac

The downward revisions to the RBA’s inflation forecasts reflect a structural change in its view on domestic inflation and wages growth.

The revisions entirely support our expectation of a further rate cut in August. With inflation now driving the policy decision and rates so low, we would be surprised if the Bank chose to move any earlier.

For now, we think they will stick with a plan to re-assess the inflation outlook after the next inflation report (due July 27) and deliver a further rate cut at the Bank’s August meeting.

Updates on wage inflation (May 18), unit labour costs (with the Q1 national accounts release on June 1, a week prior to the RBA’s June meeting), and a wide range of inflation expectations measures will also be of keen interest.

Paul Bloxham, HSBC

Given the long period of expected below target inflation, there is a key question, in our view, about whether the RBA’s rate setting has fallen behind the curve? Would a cut in November of last year, when the Q3 2015 underlying inflation measures also surprised on the downside, have helped to keep inflation on target? Would further jawboning of the currency in December 2015, as had been done in the previous two years, have helped to push the currency lower, and thus lift inflation?

Counterfactuals are tricky, but the now sustained below target inflation forecast provides some evidence that moves like these may have helped to keep inflation on target. One thing this suggests is that if the RBA is behind the curve, then catching up will probably require more than the 25bp cut delivered this week.

We expect a further cut in August. Given the election that is expected on 2 July, we see a June or July cut as unlikely. Today’s RBA inflation forecasts suggest that the risk is that even more than one further cut could be needed.

George Tharenou, UBS

We had expected the RBA to cut their inflation forecasts in today’s May SOMP, but the size of the downgrade was arguably unprecedented.

The combination of ongoing solid real growth, but sharply lower inflation argues strongly that the RBA has effectively shifted to the UBS view of structurally lower inflation as its own base case.

We reiterate our view the RBA is likely to cut the cash rate another 25bp to a record low of 1.50%, probably at its August meeting post Q2 CPI data, but there is now risk of further easing beyond this.

Key to the cash rate outlook will be the extent to which a lower AUD ultimately adds some upward pressure to inflation, as well as how quickly demand picks up in response to lower rates.

Felicity Emmett, ANZ

The question is now about the timing of the next move. The size of the downgrade to the inflation forecasts and the extent of adjustment required in real rates argues for a rapid shift down in the cash rate, and another cut in June.

But the last time the RBA did back-to-back cuts was 2012. Then the cash rate was coming from 3.75%, rather than the 1.75% where we are now. This low level of rates is a compelling argument to be cautious about further easing. On balance we expect that the RBA will wait until August, but a June move shouldn’t be completely discounted.

Gareth Aird, CBA

his is a big downward revision and indicates that the incredibly soft QI inflation report took the Bank by surprise. We note that comparisons with the RBA’s previous inflation forecasts have been complicated this time around due to the Bank moving to presenting ranges for GDP and inflation in half percentage point increments, rather than quarter percentage point increments.

We doubt that the May rate cut was a ‘one-off’ and have penciled in further policy easing in August after the Q2 CPI.

Annette Beacher, TD Securities

While another RBA cash rate cut to 1.5% was seen as all-but a certainty after we digested this week’s Board statement, on this new low inflation outlook the markets can be expected to not only fully price 25bp in August, but could price around 50/50 for a follow-up November cut to 1.25%.

(It also) increases the odds of a cut in June or July.

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