TD Securities: Falling terms of trade makes an RBA rate cut in May 'certain'

Toyota’s Altona plant is set to close in 2017. Photo Quinn Rooney/Getty Images

TD Securities Head of Asia Pacific Research Annette Beacher is certain the RBA is going to cut in May after the ‘shock’ decision to leave rates at 2.25% this week.

Beacher doesn’t hold that view simply because she thought they were going to cut in either April or May. Rather, she says the Governor’s framing of the fall in commodity prices sets the scene for another cut:

What stood out was the RBA Governor framing the recent precipitous fall in the iron ore price as “Prices for key Australian exports have also been falling and therefore Australia’s terms of trade are continuing to decline”. So rather than repeat the existing mantra that the AUD was “above estimates of fundamental value”, the Bank chose more a wide-ranging phrase to communicate the same message, and more.

The key for Beacher is that falling terms of trade “translates into negative national incomes” as Australia witnessed last year. “We could see a repeat later this year,” Beacher said. That means that “Short of iron ore falling to $US30/t, we see the terms of trade falling up to 10% this year, despite the hefty -7.5% fall last year.”


Beacher says that:

  1. Outsized iron ore shipments continue to drive down price.
  2. Iron ore accounts for 34.7% of the RBA commodity price index (which shapes the export price index). Not 100%.
  3. The flat RBA index in Q1 suggests flat export prices but we now expect the RBA index to fall by around 9% over Q2.
  4. The terms of trade could fall -2% in Q1 and another -4% in Q2, hence we could be bracing for another round of “income recession” GDP prints later this year.

This, according to Beacher, means that with a fresh set of economic forecasts for the next Board meeting on May 5, and with the last Statement on Monetary Policy incorporating market pricing of a 2% cash rate that this combination “fits our base case that the RBA can easily deliver a 25bp cut in the cash rate to 2%, citing weaker incomes. And by leaving the easing bias intact, keep downward pressure on the AUD (we target $US0.76 by June).”

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