Dr Shane Oliver, Head of Investment Strategy & Chief Economist at AMP, discusses the cash rate.
Key points:
- At its December meeting the RBA left the cash rate on hold at 4.35% as widely expected, leaving it unchanged for 13 months now.
- The RBA’s rates guidance pivoted to be more dovish though. It continues to note that underlying inflation is “still too high” and the labour market remains “tight”, but its statement noted that it is “gaining some confidence that inflation is sustainably moving towards target” noting softer than expected recent economic data, weak growth in output and weaker than expected wages growth. Governor Bullock’s comments were consistent with the more dovish tone and noted that the RBA did not consider a cut or a hike at this month’s meeting and reiterated that the RBA does not have to see two good quarterly inflation reports in a row before easing and will also look at other data.
- We moved to May as our base case for the timing of the first rate cut, but we think the RBA should start cutting in February and today’s RBA commentary suggests that there is now a high chance of that. December quarter underlying inflation data in late January along with jobs and business survey data will be key.
The RBA holds rates at 4.35% and pivoted dovish
In leaving rates on hold the RBA noted that inflation has fallen substantially from its 2022 peak, but that underlying inflation remains too high, the labour market remains tight, productivity remains weak and demand still appears to be above supply in the economy.
However, RBA commentary is now distinctly more dovish than in November noting that its “gaining some confidence that inflation is moving sustainably towards target” and cites softer than expected recent economic data, weak growth in GDP and wages growth easing more than expected.
And it’s post meeting statement dropped references to “not ruling anything in or out” and about the need for policy to remain restrictive.
The RBA’s rates guidance now has a slight dovish bias. This is what would be expected if the RBA is preparing for eventual rate cuts.
Note that the RBA, like other central banks, won’t need to wait until underlying 12 month ended inflation is in the target range before starting to cut but is just waiting for more confidence that that will be the case.
Overall, we are not there yet but do appear to be getting much closer to a rate cut.
We think the RBA should be cutting sooner rather than later
Our assessment remains that the RBA should be cutting rates sooner rather than later. While productivity growth is depressingly weak and makes the RBA’s job harder: the economy is coming in weaker than expected with an ongoing per capita recession softening concerns about excess demand; private demand in the economy is on the brink of recession with the latest NAB survey pointing to the weakest conditions since the pandemic; this combined with soft job ads and business hiring plans points to a high risk of significantly higher unemployment ahead; falling wages growth points to falling services inflation; core or underlying inflation in Australia is not that different to other comparable countries that have started to cut rates; business surveys show a continuing downtrend in in selling price growth; and December quarter trimmed mean inflation is likely to slow to 0.6%qoq or less which is a pace consistent with the 2 to 3% inflation target.
Looking at some of these point in charts. The November NAB survey shows a downtrend in cost and price pressures with final product price growth running at 0.6%qoq or 2.4% annualised which is consistent with the inflation target.
Source: NAB, Bloomberg, AMP
While there is much focus on Australia being a laggard in getting inflation down, in reality its not that different to other comparable countries. This includes for core or underlying inflation where Australian inflation is similar to that in the US and UK. While Australia did not raise rates to 5% plus like most of these countries Australians have seen a far bigger hit to their disposable incomes from rising mortgage rates. Relative to target – which is 2.5% in Australia versus 2% in the other countries – there is very little difference. Unemployment at 4.1% is also about the same as in the US and UK.
Source: Bloomberg, AMP
Our Australian Pipeline Inflation Indicator points to a further fall in inflationary pressures ahead – and our Indicator does not take account of government “cost of living” relief, being more a guide to underlying pressures!
Source: Bloomberg, AMP
As a result of weak growth and ongoing evidence of falling underlying inflation we think the RBA should be cutting sooner rather than later, ie, in February. But while the RBA has become more dovish, it still doesn’t appear to be in a hurry to cut as it waits for some more confidence “that inflation is moving sustainably towards target”. So for now we will leave our base case for the first cut being in May (which we revised from February two weeks ago). However, we think the RBA will be flexible and will look at forward looking indicators so there is high chance of a February cut (at around 50%), if December quarter trimmed mean inflation is 0.6%qoq or less, forward looking indicators remain weak, and jobs data is softer as we expect.
The money market has now moved to a 65% chance of a cut in February and nearly two cuts priced in by May. But as know they swing around a lot (a bit like economists’ forecasts!).
Source: Bloomberg, AMP
Ends
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