On the back of a lower inflation outlook and confidence that recent regulatory measures to reduce risks in Australia’s housing market were working, the Reserve Bank of Australia cut interest rates to a record-low level of 1.75% at its May policy meeting.
The decision, confounding most economists who were expecting the RBA to leave rates unchanged, had an immediate market impact, with Australian stocks and bonds rallying hard while the Australian dollar tumbled by 1.5% against its US counterpart.
Now, after taking rates to unprecedented lows, the question everyone in markets is now asking is whether the RBA will follow up today’s rate cut with another in the months ahead.
Now that markets have had time to digest the decision, and in some cases pick themselves up off the floor, it’s time to see what Australia’s economic community has made of it all.
Will it be “one-and-done” when it comes to rates, or the precursor to another rate cut, delivering back-to-back easings as the RBA has tended to do before.
We start with Paul Dales, chief Australia and New Zealand economist at Capital Economics, who has long held the view that interest rates would fall.
Paul Dales, Capital Economics
Today’s decision by the Reserve Bank of Australia to cut interest rates will help solve the economy’s twin problems of too slow growth and too low underlying inflation. It also vindicates our decision to forecast that rates would fall further even when most others thought that 2.0% would be the floor. The RBA will probably cut rates to our long-held forecast of 1.5% soon.
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.
What happens then would largely depend on the response of inflation expectations. If they remain at healthy levels, then 1.5% will probably be the floor. If they fall, as they have done in New Zealand, then rates may have to drop below 1.5%.
Tim Toohey, Goldman Sachs
The rationale for why the RBA has chosen to recommence an easing cycle is consistent with our previously published views; a likely undershooting of the inflation target, slowing economic growth momentum, a moderation in some of the employment data and signs that macroprudential policies have had some success in containing excess credit growth.
History has shown that since 1990 the RBA has not been overly influenced by political and leadership events. The RBA has eased on 3 occasions (the 1991, 2003 and 2013 elections) and hiked once (the 2007 election) in the month of or the month prior to a federal election. Moreover, Governor Stevens did continue a tightening. However, there is no occasion where both an election and a leadership transition have occurred in such close proximity and certainly not when interest rates were at historic lows.
As such, it would seem more likely that the next window for the RBA would be late in 2016, partly due to the cluttered calendar, partly because Governor Stevens would likely like to leave some monetary bullets for his successor and partly with an eye to encouraging consumer spending into the end of the calendar year. We continue to forecast the RBA to ease policy one final time in November 2016. Even this date has complications, since it will coincide within a week of the 2016 US presidential election.
James McIntyre, Macquarie Securities
Whilst the underlying inflation outcome provided the motive, the RBA’s comments in the Statement on the housing market and financial stability concerns provided the means. As we have highlighted, the introduction of tighter lending standards and the evolving supply-demand dynamic have created the conditions where rates are no longer ‘hostage’ to housing market developments to the same degree. The RBA’s statement acknowledges similar, stating, “the potential risks of lower rates in this area are less than they were a year ago”.
We remain of the view that the RBA has more work to do. But at present we are not inclined to forecast an automatic follow-on rate cut in August. Our current forecast is for a further 25bp rate cut in November. Market expectations had not fully incorporated a cut at the May meeting. We would expect that a degree of further easing will be priced in from here. That should work to put downward pressure on the AUD, which we currently forecast to reach US$0.74 by June, and US$0.69 by end-16.
Shane Oliver, AMP Capital
While the RBA seems reasonably content with the rebalancing of the economy, its clearly concerned that if it doesn’t act quickly then low sub-target inflation as we have seen recently will start to feed through to inflation expectations and become self-perpetuating just as Japan has seen over the last two decades.
The RBA also referred to an appreciation in the AUD complicating the economic adjustment in the economy, so the Australian dollar’s strength was clearly a secondary factor justifying the cut.
Will there be another cut? Interest rate moves are a bit like cockroaches – if you see one there is usually another one lurking nearby. So given the downside risks to inflation, the upside risks to growth from a loss of momentum in housing construction and the upside risks to the AUD if the Fed continues to delay rate hikes our view is that there is likely to be another rate cut taking the cash rate to 1.5%.
Given the RBA’s predilection for moves in mid quarter months when it reviews its economic forecasts this is most likely to come in August.
Alan Oster, NAB
The RBA has demonstrated that it remains a committed inflation targeter, reducing the cash rate to a record low 1.75% to improve prospects for sustainable growth in the economy and for inflation to return to target across time.
The Bank repeated the view that the economy is making the necessary adjustments, but that an appreciating exchange rate could complicate these adjustments. This is a thinly-veiled warning that a higher exchange rate would not be desirable.
The statement gives no indication of a further easing bias – not that that is unusual directly after an easing move. An easing bias likely still exists and could be acted upon should inflation continue to undershoot. In that context the next live meeting is probably August.
That said for the foreseeable future, NAB expects the RBA to remain on hold at 1.75%.
Paul Bloxham, HSBC
Although growth remains solid, which has supported business conditions and seen the unemployment rate edge lower, it has been insufficient to lift inflation. This partly reflects that the rebalancing of growth following the mining investment boom has seen growth run at a below trend pace for three years so far.
The RBA also noted that risks from the housing market have abated over the past year. Tightened lending standards and slower house price inflation have helped to allow the RBA room to lower rates further, without the risk of overinflating the housing market.
Cutting today, rather than waiting, also has the added advantage that a further RBA move prior to or just after the 2 July election is now unlikely, which helps to keep the central bank out of the way of the political process.
Nonetheless, given the scale of the downside surprise to Q1 inflation, and the continued low global inflation environment, we doubt that today’s rate cut will be enough to get underlying inflation back on track. We expect the RBA may need to deliver a further 25bp cut in Q3, probably in August, following the Q2 CPI print.
Adam Boyton, Deutsche Bank
By easing – and in particular citing “very subdued growth in labour costs and very low cost pressures elsewhere in the world, [which] point to a lower outlook for inflation than previously forecast” – the RBA has decided to take a narrower interpretation of the “two to three per cent, on average, over the cycle” inflation target than we had anticipated.
That has a number of implications for the likely future course of monetary policy, given the long lags between changes in monetary policy and changes in unit labour costs.
The RBA will need to rely quite heavily on a lower exchange rate to lift inflation. Given it takes a relatively large exchange rate move to have a relatively small impact on inflation, returning inflation to the band over the next few years is likely to ultimately require the market to conclude the cash rate is heading toward (indeed below) Fed Funds.
We expect the RBA to ease by another 50bps (after today’s 25bp), bringing the cash rate to 1.25% on a one year horizon as inflation ‘fails to lift’. We will nominate 25bps in August 2016, then a pause, followed by 25bps in May 2017. Additional easing beyond that point could well be required depending on the actions of other central banks.
Bill Evans, Westpac
Inflation has become the most important policy driver as a result of this decision and we do not expect that the June quarter report will provide the Bank with sufficient comfort around the inflation outlook.
We have been surprised by the strength of the response of the Bank to the March quarter inflation report. Having once again reverted to lower rates despite much questioning of the effectiveness of monetary policy the Governor has revealed an inclination to continue to use monetary policy in pursuit of his inflation target. With the risks around weak wages growth, global disinflation and potentially slowing demand it seems highly likely that he will choose to cut rates further with the next move timed for August. That is likely to be the last policy move from this Governor who is scheduled to retire in September.
We have also revised our own view that the Fed will delay its decision to resume raising rates until September from the current forecast of June. While a respectable case remains for June there does not appear to be sufficient urgency from the Federal Reserve to move by June. From there we expect that the FED will resume its six month timetable with the next move timed for March rather than December.
Felicity Emmett, ANZ
With last week’s Q1 inflation report showing underlying inflation well outside the Bank’s 2-3% target band, the RBA clearly felt compelled to cut rates. Ee expect that Friday’s SoMP will show the forecasts for inflation staying below the band until at least early 2017. The prospect of a prolonged period of inflation outside the band was clearly too uncomfortable for the Bank.
This is unlikely to be a “one and done” cut. The RBA nearly always follows up with another cut. And we expect this time to be no different. Whether the follow up cut comes next month or in August (after the next CPI report, and before the August SoMP) is difficult to be too certain about. We will wait for more ‘colour’ in Friday’s SoMP to make that call.
Scott Haslem, UBS
Key to today’s decision was the RBA concluding “prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting”. The RBA followed their normal practice of providing no ‘forward guidance’ on policy at meetings where they actually move rates. As such, notwithstanding the lack of an ‘explicit easing bias’, having just cut, the RBA must still be considered as holding an easing bias.
Given our view that that structural disinflationary forces have likely intensified in Australia, and the RBA’s revealed concern about the risk of persistent low inflation, we now look for a follow-up 25bp cut to 1.5% in August, post Q2 CPI. Thereafter, we expect the cash rate to remain unchanged until at least end-17.
Michael Blythe, CBA
The RBA decision to cut the cash rate to a new record low of 1.75% looks to have been a finely balanced one.
The domestic economy does not need additional support. GDP growth rates remain comfortably positive despite the headwinds from falling commodity prices and the end of the mining construction boom. Jobs growth rates remain comfortably positive and the unemployment rate is trending down. Tonight’s Budget is set to ramp up infrastructure spending, something RBA Governor Stevens has called for to take the some of the pressure off monetary policy. A rate cut against that backdrop looks unusual.
The decision to cut rates, therefore, indicates a level of concern about the inflation trajectory that looks overdone in our view.
The RBA’s concerns about entrenched low inflation (including labour costs and global inflation) mean that another rate cut is likely. We have pencilled in another 25bpt cut to 1.5% in August on the usual post-CPI timetable.
Annette Beacher, TD Securities
We see low domestic and global inflation as reasons to reformulate decades-old inflation targets, not spur a race to ZIRP/NIRP policies like Australia’s G10 peers. Nevertheless, the RBA rarely moves in isolation, and so the market is likely to expect another 25bp cut to 1.5% in due course.
So if low inflation now and lower inflation ahead was the driver behind today’s cut, we pencil in and suspect consensus also expect an August cut (currently 60% priced) the timing being after the June quarter CPI report is released in late July.
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