BAML outlines what it will take for the RBA to stop talking about raising rates

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  • The RBA cash rate has remained at 1.5% for over two years.
  • Earlier this year, markets were firmly of the view that the next move in the cash rate would be higher. But that’s now changed.
  • Markets are now pricing in a small possibility that the next move in the cash rate will be down, not up.
  • The RBA still believes that the next move is likely to be higher, even with weak Australian economic growth in Q3.
  • For the bank to change that view, BAML says it will likely require a deterioration in the global economy given the current outlook domestically.

  • This year, as was the case in 2017, will go down as a year that the RBA cash rate did nothing.

    Not since August 2016 has it moved, a decrease of 25 basis points, leaving it at 1.5%, the lowest level on record.

    However, while the cash rate hasn’t moved for well over two years, that hasn’t stopped financial markets from speculating as to what direction the next move will be.

    As seen in the chart below from Bank of America Merrill Lynch (BAML), financial markets have had a change of heart this year, moving from pricing in the first increase in the cash rate since late 2010 to now speculating about a possible decrease next year.

    BAML

    The chart uses pricing from Australian interbank cash futures. The chart is now dated by a few days, but the status quo remains.

    Rather than a greater chance of a hike arriving next year, there’s now greater probability being attached to a cut.

    The recent switch of mindset reflects a big undershoot in Australian economic growth in the September quarter, coming in well below what most expected, including the RBA.

    The weakness was primarily concentrated in household spending, raising concern that weakness in some of Australia’s largest housing markets, at a time when household income growth is soft, could lead to a sharp slowdown in the economy, leaving little choice but for the RBA to act.

    Or at least signal it’s prepared to act to support economic activity.

    Right now, the RBA still thinks the next move in the cash rate is likely to be higher, a view that’s been reaffirmed by senior bank officials even after the big Q3 GDP undershoot.

    So what will make the RBA change this view, confirming what markets are already speculating upon?

    Tony Morriss, Head of Australia and New Zealand Economics and Rates Strategy at Bank of America Merrill Lynch, says rather than being domestic factors, such a decision would likely be brought upon by international, rather than domestic, factors.

    “Any shift in guidance is more likely to come from a weakening of the global backdrop and China remains a key risk,” Morriss says, adding that “loose financial conditions and fiscal flexibility helps to insulate against any weakening of the global outlook and housing”.

    And should the domestic economy stutter unexpectedly, Morriss says the RBA has already made it clear from recent commentary that it will still be prepared to act.

    “In the unlikely scenario that domestic conditions deteriorate from a weaker labour market then the RBA has signaled their readiness to act especially if the availability of housing credit continues to fall,” he says.

    Morriss expects no such scenario will arrive next year, suggesting that above-trend economic growth will continue to help reduce labour market slack and lift inflationary pressures, eventually pacing the way for the next move in the cash rate to be up.

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