The evolution in market expectations for the RBA cash rate, in one chart

Narayan Maharjan/NurPhoto via Getty Images
  • Just over three months ago financial markets thought the next move in the RBA cash rate was likely to be higher. However, that’s now changed.
  • Financial markets are convinced the cash rate will be reduced by this time next year.
  • Upcoming data on inflation, labour market conditions, especially leading indicators, and Australia’s Q4 GDP report will likely determine whether markets will be proven correct.

Just over three months ago financial markets thought the next move in the RBA cash rate was likely to be higher, albeit not for quite some time.

However, that’s all changed.

Instead, of thinking the next move will probably be higher, markets, collectively, think the cash rate will be cut by this time next year.

This excellent chart from Westpac Bank shows the shift in market expectations for the cash rate since the middle of last year.

Westpac Bank

The purple line shows market pricing on December 5, when the RBA held its final meeting of 2018.

One day later, Australia’s Q3 GDP report was released, revealing a steep slowdown in economic growth that created renewed doubt over the RBA’s optimistic forecasts for a gradual decline in Australia’s unemployment rate, and gradual lift in inflationary pressures, in the years ahead.

That saw a swing from pricing in the likelihood of rate hikes to rate cuts, something that has continued into early 2019 following a series of weak economic indicators, including another very soft Q4 CPI print in late January.

The RBA’s acknowledgment this week that downside risks have increased, explaining why the bank has now switched to a neutral bias on the outlook for the cash rate having adopted a mild tightening bias since early 2018, has seen markets move to fully price a rate cut by February next year, with the small risk of a second.

Whether markets are right will likely be determined by data on inflation, labour market conditions, especially leading indicators, and Australia’s Q4 GDP report that will be released in early March.

Another weak result will only fuel the belief that steady policy settings, without help from stronger economic growth abroad or fiscal stimulus from the Australian government, are inappropriate if the RBA is to achieve its inflation mandate.

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