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

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  • It’s almost certain the RBA will cut Australia’s cash rate for the first time since August 2016 this week.
  • Financial markets are fully priced for a 25 basis point cut to be delivered. All bar one economist polled by Bloomberg expects the cash rate will fall to 1.25%.
  • Given almost everyone thinks the RBA will cut rates, TD Securities has looked at how financial markets are likely to react under a variety of different scenarios.
  • TD believes the most likely outcome will be that the RBA cuts rates and provides little commentary as to whether or not it will ease policy settings again.
  • It puts the odds of the RBA not cutting rates at less than 1% given the reputational damage it would cause.
  • TD believes the largest market reaction may not actually come from the wording of of the June statement but rather what RBA Governor Philip Lowe will say when he speaks several hours after the policy decision is released.

The Reserve Bank of Australia (RBA) appears certain to cut Australia’s cash rate for the first time since August 2016 when it announces its June monetary policy decision on Tuesday.

Financial markets are fully priced for a 25 basis point rate cut to be delivered. All bar one forecaster of the 30 surveyed by Bloomberg also expect the cash rate will be reduced to a new record low of 1.25%.

TD Securities Markets believe the RBA will deliver two 25 basis point rate cuts this year, with a meaningful risk of a third cut also priced in.

Put bluntly, unless the RBA decides to do untold damage to its credibility in financial markets, it will cut rates come 2.30pm AEST in Sydney.

Given a rate cut is deemed to be nearly as certain as night following day, it begs the question: how will Australian financial markets react?

Ahead of the actual rate decision, TD Securities has produced this nifty table showing how the Australian dollar and interest rate markets are likely to respond to what the RBA says in the accompanying June monetary policy statement.

TD Securities

As discussed above, TD puts the odds of a non-move from the RBA at less than 1% given the reputational damage it would cause.

“The OIS [overnight index swap market] is fully priced for a cut this month,” TD said in a note released on Monday. “If the Bank does not cut tomorrow, the market would seriously question the RBA’s communication strategy.”

In the absence of a shock, credibility-sapping decision, to keep the cash rate unchanged at 1.5%, TD deems the most likely scenario on Tuesday to be for the RBA to cut rates by 25 basis points and provide little indication as to whether or not it will ease policy settings further in the period ahead.

In such a scenario, TD says the final paragraph of the June statement, where the bank typically outlines its bias on the outlook for policy settings, will say something along the lines of: “Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting”.

That’s the exact line used by current RBA Governor Philip Lowe’s predecessor, Glenn Stevens, when the RBA last cut rates in August 2016.

Given Lowe has never moved Australia’s cash rate during his tenure as RBA Governor, there’s no guarantee he will adopt the same approach used by Stevens in the past, but TD believes a similar scenario is likely again on this occasion.

“The RBA has traditionally refrained from injecting a bias when the cash rate has been cut. We expect the same this time,” TD says.

Outside of that scenario, deemed to be a 70% chance in TD’s opinion, it says there’s a reasonable risk the RBA may cut rates but signal a willingness to hold off on easing policy settings further.

“Any language suggesting the RBA can afford to ‘wait and see’ developments post the election and APRA changes would be viewed as ‘hawkish’,” TD says.

It puts such a scenario occurring at 20%, double the probability of the RBA cutting rates and communicating that it intends to ease policy again in the near-term.

While financial markets will react to the wording of the June policy statement one way or another, TD believes the largest market moves may actually occur when RBA Governor Philip Lowe delivers a speech several hours after the initial decision is released.

“Governor Lowe’s speech on Tuesday at 7.30pm AEST is likely to be more influential for markets,” TD says.

Before the June monetary policy statement is released, financial markets are fully priced for the RBA to deliver a follow-up 25 basis point cut by September.

There’s also a meaningful risk of an additional 25 basis point cut — taking the cash rate to just 0.75% — being priced in by the middle of next year.

Given those expectations, near-identical to that conveyed by economic forecasters over the same period, Lowe will likely use his speech to either confirm or push back upon just how far policy settings are likely to be loosened.

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