This indicator suggests there's currently more pressure on the RBA to cut interest rates than raise them

Laurens Lindhout/Soccrates/Getty Images

The Reserve Bank of Australia (RBA) will release its quarterly Statement on Monetary Policy (SoMP) tomorrow.

It’s an important document, outlining the bank’s assessment of current economic conditions, both at home and abroad.

It also contains the bank’s updated economic forecasts, including for inflation. As an inflation-targeting central bank, where it sees inflation in the future is highly influential on what direction interest rates will move next.

That ensures all eyes tomorrow will turn to its inflation forecasts, especially for underlying inflation, the bank’s preferred measure of gauging price pressures.

Based on what the RBA said in Tuesday’s February monetary policy statement, it appears cautiously optimistic that inflationary pressures will “gradually” build, leading the vast majority in financial markets to predict that the next move in interest rates in Australia will be higher.

The only question many are now asking is when will rates rise.

Some think it could be as soon as May this year, while others think it could be well into 2020 before policy normalisation will begin.

If this indicator is any guide, it could be far longer than what many expect, at least based off previous inflation forecasts offered by the RBA last November.

Source: Deutsche Bank

It’s Deutsche Bank’s “RBA hiking / easing pressures indicator.” The model uses the RBA’s inflation forecasts, stress levels in financial markets and current labour market trends in Australia to determine how much “pressure” the RBA is under to lift or cut interest rates.

The lower the reading, the more pressure there is perceived to be on the RBA to cut rates. Conversely, the higher it is, the more perceived pressure there is for the bank to lift interest rates.

It has a reasonable track record for predicting movements in the RBA cash rate seen in the past.

Based off the RBA’s latest inflation forecasts, rather than indicating the bank is under pressure to lift interest rates, it actually suggests its under pressure to cut rates.

“The surprise for us when we constructed this indicator is just how deep the downward revisions to the inflation forecasts in the November SoMP pushed the indicator into easing territory,” says Adam Boyton, Chief Australia Economist at Deutsche Bank.

Ahead of Friday’s SoMP, Boyton says even an upgrade to the bank’s headline and underlying inflation forecasts will not guarantee that the indicator will move back into tightening territory given the recent bout of volatility across financial markets.

“Prior to the most recent equity market sell-off it would take — on the current decline in the unemployment rate — terminal inflation forecasts of 2.5% on headline and 2.5% on underlying in Friday’s SoMP to drag us just back into tightening territory,” he says.

“But now — should volatility in markets remain at levels seen over recent days — even quarter-point upward revisions to the RBA’s ‘terminal’ inflation forecasts on Friday will leave our indicator in easing territory.”

While this is a model, not the RBA board who actually decide what to do with interest rates, Boyton says it underscore that rate hikes from the RBA appear to be some way off.

The RBA SoMP will be released at 11.30am AEDT on Friday, February 9.

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