Here's a playbook on how markets may react to the RBA's interest rate decision

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  • The Reserve Bank of Australia (RBA) hasn’t moved Australia’s cash rate since August 2016.
  • A slim majority of economists polled by Bloomberg expect the RBA will cut the cash rate by 25 basis points on Tuesday. Financial markets attach a 47% probability of such an outcome eventuating.
  • TD Securities has evaluated how financial markets are likely to react to a variety of different scenarios occurring.

The Reserve Bank of Australia’s (RBA) May interest rate decision is nearly upon us, with the question of whether or not it will cut Australia’s cash rate for the first time since August 2016 soon to be answered.

To say it will be a blockbuster event is an understatement.

A slim majority of economists polled by Bloomberg expect the RBA will cut rates by 25 basis point, taking the cash rate to a new record low of just 1.25%.

Financial markets, based on current pricing of Australian interbank futures, also put the odds of a 25 basis point rate cut being delivered at 47%.

It’s basically a flip of a coin as to what the RBA may do come 2.30pm AEST on Tuesday, and not only in terms of what the actual rate decision will be but also what the RBA may say in the accompanying May monetary policy statement.

Ahead of the decision, TD Securities has taken a look at how markets are likely to react based on a variety of possible scenarios. It’s even been kind enough to provide a probability of each scenario occurring.

Here’s a nifty table released by the group on Monday that details how markets are likely to react.

TD Securities

The commentary for each scenario reflects what the RBA may say in the final paragraph of the statement where it communicates it’s bias on the outlook for the cash rate.

TD Securities deems a 25 basis point rate cut as the highest probability scenario at 45%, narrowly ahead of no rate cut but the adoption of an explicit easing bias at 40%.

An explicit easing bias implies the RBA is likely to cut the cash rate in the period ahead.

In terms of outlier outcomes, TD deems the odds of no rate cut and no easing bias being introduced at less than 5%, with an even smaller probability being attached to a scenario where the RBA cuts rates but adopts a clear neutral bias, implying the move is unlikely to be repeated in the near-term.

A scenario where the RBA cuts rates and adopts an explicit easing bis is deemed to be a little higher at 10%, according to the group.

If the RBA want to deliver the maximum market reaction to a rate cut, this scenario would undeniably be the most effective.

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