The RBA rate cut club has a new member

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  • There’s no shortage of economists out there who think the RBA will cut official interest rates this year. Morgan Stanley has recently joined that list.
  • It says it will take some time for slower economic growth, and a slowdown in hiring, to lead to an increase in unemployment.
  • Morgan Stanley sees the first of two 25 basis point rate cuts arriving on Melbourne Cup Day in November.
  • The RBA has stated that a sustained increase in Australia’s unemployment rate could warrant a further reduction in the cash rate.

There’s no shortage of economists out there who think the Reserve Bank of Australia (RBA) will cut official interest rates this year.

Morgan Stanley has recently joined that list.

However, unlike most others who see easier policy settings arriving in the months ahead, it says it will take quite some time for the RBA to act, suggesting that rather than preemptive rate cuts to stave off a more pronounced economic slowdown, it will only act after the horse has bolted.

“We don’t think the current softness in the labour market will be enough to see the RBA proactively cut in the near-term as some are expecting,” Morgan Stanley’s Australian Equity Strategy team said.

“While jobs have slowed they are still at a level consistent with unemployment reduction, and unless the RBA dramatically revises down their growth forecasts in May, which we don’t expect, they are unlikely to feel like they need to move.”

In February, Australian employment only grew by 4,600, undershooting expectations for a larger increase of 15,000. However, despite the slowdown in hiring, unemployment fell to 4.9% — the lowest level in eight years — as 7,100 Australians left the labour force.

Last month, RBA Governor Philip Lowe said that a sustained increase in Australia’s unemployment was one scenario, along with slow or no progress in returning inflation to the RBA’s target, that could warrant a further reduction in the cash rate.

Despite Morgan Stanley forecasting that Australia’s economic slowdown will become even more pronounced this year, predicting paltry growth of just 2% compared to the RBA at 3%, it believes it will take time for the expected slowdown in hiring to start placing upward pressure on unemployment, providing the necessary trigger for the RBA to cut rates.

“Given our below consensus GDP outlook for 2019 we expect the unemployment rate to increase to 5.3%, but only gradually and later in the year than many expect,” it said.

“Ultimately it will be the length and not the depth of this slowdown that drives them to cuts.”

Given that view, Morgan Stanley sees the RBA cutting Australia’s cash rate on Melbourne Cup Day in November, and again in February next year, leaving it at just 1%.

The vast majority of economists who are forecasting twin rate cuts this year believe the RBA will go far earlier than Morgan Stanley expected, perhaps as early as May depending on incoming data and the size of potential fiscal stimulus in April’s federal budget.

While Australia’s unemployment rate has taken on greater significance in recent months, other leading labour market indicators are also garnering greater attention given the signals they provide on the likely strength in hiring in the period ahead.

Although most have softened in recent months, substantially in some cases, the RBA appears to be placing significant weight on official job vacancy data from the ABS to justify its view that strong hiring will help to place gradual downward pressure on unemployment in the years ahead.

“Leading indicators of conditions in the labour market, such as vacancies and hiring intentions, pointed to further tightening in the labour market in the near term,” the RBA said at its March monetary meeting.

Markets will get updated vacancy data for February later this month.

Given the RBA’s forecasts for the economy and inflation are underpinned by a continuation of recent labour market trends, any sign of weakening in this report will likely see rate cut expectations strengthen further, even with the recent decline in the unemployment rate.

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