This CBA team found a tiny change to the RBA’s April statement that suggests two cuts in 2016

Photo: Sherlock/ BBC.

While the vast majority of economists expect that the next move in Australian interest rates will be higher, albeit after an extended period at present levels, interest rate traders, collectively, share a different view.

Even after yesterday’s unchanged rate decision from the RBA — the 11th month in succession that the cash rate has been left at 2.0% — they continue to price in a further 0.25% rate cut arriving in the months ahead.

According to Australian interest rate futures, the probability of a 0.25% reduction in the cash rate on May 3 — less than a month away — is seen at 35%. Further out the curve, the odds rise to over 100% by November, indicating that markets are not only expecting one rate cut, but potentially two.

The view of economists to interest rate traders is close to polar opposites.

The chart below, supplied by CBA, shows the evolution in Australian cash rate expectations over the past six weeks.


CBA’s fixed income strategy team, led by Adam Donaldson, are one group who don’t believe the RBA’s rate cutting cycle is over, suggesting that the RBA will deliver a further two 25 basis point rate cuts this year, taking the cash rate to a fresh record low of just 1.50%.

They point to a small, and to many overlooked, change in the final paragraph in the RBA’s April monetary policy statement to justify their view.

“There was also a subtle change in the way inflation is dealt with in the statement. Multiple times previously the RBA has said ‘continued low inflation would provide scope for easier policy’,” they wrote in a research note released late on Tuesday. “This time, however, the inflation rate has started shifting from ‘scope’ to ‘impetus’ for easier policy, which would be a big change.

Here’s the final paragraph of the RBA’s March policy statement.

Over the period ahead, new information should allow the Board to judge whether the improvement in labour market conditions is continuing and whether the recent financial turbulence portends weaker global and domestic demand. Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand.

And here’s the final paragraph released in the April statement. The emphasis is CBA’s.

Over the period ahead, new information should allow the Board to assess the outlook for inflation and whether the improvement in labour market conditions evident last year is continuing. Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand.

Excluding the removal of the reference to financial turbulence, CBA suggest the addition of inflation to labour market conditions in the first sentence of the April statement is significant, especially with the March quarter consumer price inflation (CPI) report due out on April 27.

They explain:

“A low inflation print on 27 April might cause the RBA to draw some unwanted conclusions about the outlook for inflation.

“The key issues, for us, is that the higher AUD and a soft CPI print later this month could easily conspire to drag RBA inflation forecasts lower. Whether that turns 2% core in H1 and 2-3% in H2 into a sub 2% number, we’re not sure. But the revisions will be down and the number is critical given the 2% core starting point.”

Alongside recent weakening in labour market data and a moderation in house price growth, it suggests to CBA that the RBA could deliver a rate cut as early as next month, regardless of it coinciding with Budget day.

“We see the path to a May rate cut as possible, and clearly data dependent. If the AUD continues appreciate as well as the CPI number printing low and the unemployment data looking poor, then May is clearly live despite being budget day,” they wrote.

“Or, of course, it might take a little longer for the RBA to get over the line. We remain comfortable calling two further rate cuts this year – it’s just predicting the timing that is tricky at present.”

If it wasn’t already, April 27 is looking like a blockbuster day for Australian financial markets, especially should the ABS’ jobs report next Thursday disappoint.

It is also noteworthy that the view taken by CBA’s fixed income strategy team differs significantly from the bank’s economic team who see the RBA on hold for the remainder of the year.