J.P. Morgan expects the RBA will slash Australia's cash rate to 0.5%

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  • J.P. Morgan expects the RBA will slash Australia’s cash rate to just 0.5% by the middle of next year.
  • The cash rate currently sits at 1.5%
  • The bank says 50 basis points of cuts are unlikely to be sufficient to lower unemployment to levels where inflationary pressures begin to increase.
  • Financial markets see a 25 basis point rate cut in June as a near certainty. Another 25 basis point cut is also fully priced by November.

J.P. Morgan has just taken the lead when it comes to the most aggressive forecaster for RBA rate cuts in the year ahead.

In a note released on Wednesday, the bank said that it now expects the RBA will slash Australia’s cash rate to just 0.5% by the middle of next year, a full 100 basis points below the level where it currently sits.

Previously, J.P. Morgan was forecasting the RBA would deliver two 25 basis point rate cuts this year, taking the cash rate to 1%, around the same level currently expected by financial markets.

So why the change in view?

According to Sally Auld, Chief Economist and Head of Australia and New Zealand Fixed Income and FX Strategy at J.P. Morgan, it’s because 50 basis points is unlikely to be enough to lower unemployment and boost inflation in her opinion.

“Core inflation has fallen 0.5 percentage points in the last 12 months and is now expected to track a lower path in coming quarters relative to the RBA’s expectations earlier this year,” Auld wrote.

“Not only is the real cash rate [the nominal level less inflation] now at its highest level in three years, but a lower level of inflation implies that more than 50 basis points of easing will be required to return real short rates to appropriate levels.”

Linked to the soft inflation outlook, J.P. Morgan also believes just two 25 basis point rate cuts will be sufficient to lower unemployment to levels consistent with higher wage growth, a necessary ingredient required to help lift domestic price pressures.

“A simple rule of thumb is that 50 basis points of easing should bring the unemployment rate lower by 0.15 percentage points over the subsequent 12-18 months,” Auld wrote.

“Assuming a starting level of 5.2% for the unemployment rate, 50 basis points of easing appears inadequate to deliver the macro-economic outcomes necessary to deliver a pick-up in inflation.”

Along with downside risks for inflation and a lack of progress in lowering unemployment, Auld says a recent deterioration in the global economy, along with the risk of rate cuts from the Federal Reserve should the U.S. economy begin to falter, are other factors underpinning its forecast revision for the cash rate.

“The structural headwinds facing the domestic economy — a deleveraging of household balance sheets, persistently low incomes growth, a recalibration of lending standards and a rebalancing of economic growth away from housing-related activity — all demand a long period of low rates,” Auld wrote.

As for the risks to J.P. Morgan’s forecast are “two-sided”, implying the RBA may ease less or more than what’s currently foreseen.

“On the one hand, we can’t be definitive that 0.5% is the effective lower bound for the policy rate in Australia. It may well be lower, and we suspect policy makers are open-minded about this possibility given the experience in other developed economies,” Auld wrote, referring to the point where rate cuts fail to deliver any further support to the economy.

“On the other, the low level of government debt relative to GDP in Australia suggests potential for significant fiscal easing that could offset the need for a sub 1% cash rate.”

On the latter — fiscal stimulus — Auld says to the issues will be “how large a stimulus package quickly the newly elected Coalition government is willing to entertain given its commitment to fiscal prudence and how quickly it can be delivered”.

Financial markets see a 25 basis point rate cut next month as a near-certainty. Another 25 basis point rate cut is also fully priced by November. There’s also a meaningful risk of a third cut being delivered by the second half of next year.

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