Financial conditions in Australia are now tighter than they were at any of the last four interest rate cuts by the RBA says Tim Toohey, Goldman Sachs chief economist in Australia, and his team.
Even though the RBA left the cash rate on hold again yesterday it “did make some important changes in the text of its accompanying statement which opens the door to easing interest rates post the release of 1Q16 CPI data in April,” Toohey wrote in a note to clients.
As Business Insider noted yesterday, the statement seemed to be little changed but there are signs it is getting closer to cutting rates.
Toohey believes the key change made by the RBA was around inflation. He says that in “changing the phrase in the February statement from “Continued low inflation may provide scope for easier policy” to “Continued low inflation would provide scope for easier policy” means that the release of 2016’s first quarter Consumer Price Index (CPI) in late April will be key for Toohey’s expected May cut.
He also notes that “in each of the past 39 Board statements, the RBA flagged its expectation that inflation would “be consistent with target over the next one to two years” (or a very similar expression). However, in both the February and March statements this reference was altered to read “inflation is likely to remain low over the next year or two”.
Like its central banking colleagues around the world that suggests the RBA is on alert to the “prospect that underlying inflation could move below the bottom of the RBA target band a sustained period.”
That’s important because if low inflation, and low inflation expectations, become anchored in the public’s minds overall economic growth in Australia could suffer as consumers delay purchases. (I wrote at length back in December about the problems Australia is facing with low inflation here.)
In the end when he adds up this inflation outlook, global growth, the health of the domestic economy, housing, and the prospect that the Aussie dollar won’t fall as much as he, or the RBA, thought, Toohey said the RBA has
… signaled an incrementally dovish shift, via an explicit focus on below-target inflation, the challenging requirement for ongoing improvement in the labour market, and the risk that the recent tightening in global financial conditions may weigh on both global and domestic demand.
It won’t exercise the option it has granted itself just yet, Toohey says. But Goldman Sachs believes, “the RBA will ease policy in May by 25bps and follow with a further 25bps in July (although the timing of this final cut may be subject to the timing of the federal election).”