Why a RBA rate cut next week would still deliver a dovish surprise for markets

Anthony Kwan/Getty
  • Financial markets now believe it’s only a matter of when, not if, the RBA will cut official interest rates.
  • Financial markets currently put the probability of a 25 basis point rate cut next week at around 50%.
  • According to analysis from ANZ Bank, should the RBA cut rates on May 7, it would be the most unexpected rate cut since at least 2012 should current pricing be maintained.
  • A surprise move could generate a larger-than-usual market reaction despite widespread expectations for rate cuts in the months ahead.

Financial markets now believe it’s only a matter of when, not if, the RBA will cut official interest rates.

According to Australian cash rate futures, a full 25 basis point rate cut is fully priced in to occur by July, with another follow-up 25 basis point reduction also priced in by February next year.

However, despite widespread expectations that the RBA will ease policy settings further, including from most economists following Australia’s weak Q1 consumer price inflation report released last week, there’s a high degree of uncertainty as to whether or not the RBA will cut Australia’s cash rate next week.

As things currently stand, a 25 basis point reduction in May is deemed to be slightly less than a 50% probability, reflecting uncertainty as to whether the RBA will be prepared to move less than two weeks away from Australia’s federal election, particularly with unemployment still sitting at 5%, near the lowest level in eight years.

There’s valid reasons for the RBA to either cut or to hold policy rates steady when it meets on May 7.

However, if the RBA wants to deliver a dovish surprise to already dovish financial market expectations, ANZ Bank’s interest rate strategy team believes an early move could well do the trick.

“The probability of easing in May is still only priced at 50%. This is relatively low by historical standards,” strategists at the bank said in a note.

“Since the beginning of 2012, markets have on average priced a 78% chance of a cut in the month before a cut. Indeed, the 50% pricing would make a cut in May the most ‘unexpected’ over this period, the previous low being prior to the move in May 2016.”

While that suggests the RBA may be reluctant to move given the potential to surprise, if it wants to generate a larger reaction in financial markets, even with widespread easing expectations already priced in, an early move will send a powerful message that it will no longer tolerate big inflation undershoots, especially with uncertainty over other parts of the economy such as housing and household consumption already at elevated levels.

Should the RBA take the cautious path, keeping policy settings steady while initiating an easing bias to imply that it’s likely to cut rates again, that will be interpreted as another sign of reluctance to support the economy, an outcome that will likely see markets unwind some rate cut pricing, potentially making it more difficult to lift economic growth sufficiently to boost wage pressures, lower unemployment and move inflation back towards the bottom of the RBA’s target.

NOW READ: The last time Australian inflation was this weak the RBA cut rates immediately, but Westpac believes this time will be different

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.