The first economist to predict lower rates in Australia says the RBA will cut again soon

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Last year, after the RBA delivered two rate cuts, the general consensus was that they’d done enough. But that’s when Paul Dales, chief economist at Capital Economics emerged as the first forecaster to highlight the need for further drops.

His view was largely based on the fact that Australia would not escape the global phenomenon of falling prices, and thus underlying inflation would prompt the RBA to cut rates to 1.5%.

He’s halfway right after today’s RBA decision to drop rates 25 basis points to 1.75%. In a note this afternoon, Dales argues that while the governor’s statement hasn’t revealed a bias, the RBA’s own modelling suggests the need to ease further.

Here’s Dale’s rationale (his emphasis):

The RBA’s econometric model implies that each 0.25% rate cuts boosts GDP growth by just 0.15% in a year’s time and raises inflation by less than 0.1%. With underlying inflation currently 1.0 percentage point below the midpoint of the 2-3% target range, it’s very unlikely that the Bank will conclude that one 0.25% rate cut will do the job. We expect that rates will be cut to 1.5% at the August meeting, especially if the release of the CPI data for the second quarter the week before show that underlying inflation stayed low.

But it’s not just inflation Dales says which is going to drive the next cut. Rather he says the RBA noted that weaker growth and a stronger dollar are also a drag on the outlook.

Friday’s quarterly Statement on Monetary Policy gives the RBA ample opportunity to explain this decision and to release new inflation and growth forecasts. But Dales says there is a risk even the new forecasts are too optimistic.

“We’re concerned that GDP growth this year won’t even match last year’s 2.5%. Given that would be the tenth time in 11 years that growth has fallen short of the economy’s potential of 2.75%, the resulting rise in spare capacity will keep underlying inflation below 2% until the middle of 2017,” he said.

That sounds like he thinks rates might even have to head below 1.5% at some point, but Dales says that will depend on household inflation expectations.

“As long as they remain at healthy levels, then 1.5% will probably be the floor,” Dales wrote.

Dales is also forecasting the Aussie dollar to fall to 70 cents by year’s end.

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