UBS explains why the RBA could cut rates sooner than many expect

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  • UBS is forecasting that the RBA will cut Australia’s cash rate in November. It says the risk for its call is that the RBA will go sooner, not later, than it currently expects.
  • Along with a sustained increase in unemployment of lack of progress in lifting inflation, UBS says domestic house prices and the global economy are other factors that could see the RBA cut rates this year.
  • UBS nominates the federal budget as the biggest risk for its rate cut call.
  • Financial markets are fully priced for a 25 basis point rate cut by early next year. An increasing number of market economists share this view, although the majority still see the next move as being higher.

The Australian economics team at UBS thinks the Reserve Bank of Australia (RBA) will cut Australia’s cash rate by 50 basis points by the middle of next year, starting with a 25 basis point reduction in November.

Despite unemployment remaining at 5% in January, seemingly mitigating one of the triggers nominated by the RBA that could see it cut rates again in the near-term, UBS says the risks for its call are that the RBA will be cutting sooner, not later, that what it currently expects.

“Overall, the risk to our view of a November rate cut is earlier, not later,” says George Tharenou, Carlos Cacho and Jin Xu, members of the US Australian economics team.

“We expect the RBA to again downgrade its GDP outlook in May. But if they also move to an ‘easing bias’, it would make each meeting ‘live’ and raise the risk of August move over November.”

Given the past track record from the RBA to signal a rate cut is likely before the actual event, the trio say a miss in Q4 GDP growth, especially for consumption, will be likely needed to cut earlier, potentially in April or July.

Australia’s Q4 GDP report will be released on Wednesday, March 6, one day after the RBA’s March monetary policy meeting is held.

Along with another big undershoot in Australian economic growth in the December quarter, mirroring the outcome seen in the three months to September, UBS says there are other factors aside from a sustained lift in Australian unemployment and lack of progress in lifting core inflation back to within target that could get the RBA to ease policy settings further in the months ahead.

The first is continued falls in domestic home prices, the second a further deterioration in the global economy, echoing downside risks to inflation nominated by the RBA in its latest statement on monetary policy.

“If home prices keep falling, which we expect, the key is if the RBA no longer downplays the wealth effect,” UBS says.

UBS

On the global economy, UBS says its nowcast forecasting model has fallen to an annual growth rate of 2.25%, something that if reflected in reality “would confirm the RBA’s downside risk scenario”.

As for a potential risk that could see rate cuts pushed back or not arrive at all, UBS says the upcoming federal budget looms as a key event.

“The Budget is the key upside risk to our view given it’s already tracking $3 billion ahead of MYEFO forecasts, albeit we already expect $8-10 billion of tax cuts and around $5 billion in cash transfers by mid-year.

The UBS call for the RBA to cut official interest rates in November is not dissimilar to that of financial markets which, collectively, have a full 25 basis point cut priced in by early next year.

Several leading market economists, including Westpac Bank, are also forecasting the RBA will cut rates in the second half of this year.

While more economists are now forecasting rate cuts, the vast majority still believe the next move in the cash rate will be higher, albeit not until the middle of next year at the earliest.

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