MNI: RBA Rate Cut Expectations Overblown- Ex-Officials

The Reserve Bank of Australia is likely to hold its cash rate at 3.85% for longer than markets expect as global trade disruptions sustain domestic inflation pressures, former RBA economists told MNI, noting that the Bank’s latest projections show that cutting too much would drive price increases above target.

Either the central bank or the market is misreading the outlook, said Peter Tulip, chief economist at the Centre for Independent Studies and former senior research manager at the RBA, pointing to market pricing that has assigned an over-85% chance of 25-basis-point cuts at the July and August meetings.

“If the market is right and the RBA needs to cut in July and August, then the RBA’s most recent forecasts, showing inflation remaining above the 2.5% midpoint if rates fall, would need to be revised,” he said. “The market’s yield curve seems inconsistent with the bank’s forecasts. How does [the RBA] explain that divergence? Is it a different inflation forecast, a different unemployment forecast, or does the market just expect the RBA to react differently to the data?”

Tulip said markets had likely priced in a deeper impact from global trade volatility than the RBA assumed in its May projections. (See MNI RBA WATCH: Board's Dovish Turn Included Debate Of 50bp Cut) “Overwhelmingly, monetary policy decisions come down to inflation and unemployment forecasts versus targets. If inflation is forecast to be above target, then you don’t cut. I don't think they will cut as much as the market is expecting.”

May’s forecasts, largely unchanged from February, showed rate cuts would push inflation above target. “The implication being they’re not going to cut anywhere near as much as the futures profile was predicting, and the data since then hasn’t provided any real reason to revise that outlook,” Tulip concluded.

UNNECESSARY CUTS

Further 25bp cuts – or a larger 50bp move such as that discussed at the last board meeting – are not warranted given the state of the macroeconomy, said Mariano Kulish, University of Sydney professor and former RBA senior manager.

“I would want underlying inflation to be closer to 2.5% before I cut,” he said, though he added that trade-related uncertainties could still deliver a negative supply shock and that short-term U.S. dollar weakness may lower imported inflation and add pressure on the board to ease policy at the July and August meetings. 

Even with two cuts, the cash rate would remain contractionary – especially given weak productivity, Kulish noted. “Presently, policy is consistent with a real cash rate of 85bp, so you could consider cutting another 25-50bp. But I'm still of the view that the economy needs a somewhat higher real interest rate to cement inflation in the band." (See MNI: Weak Productivity To Cramp RBA's Easing Path - Ex Staff)

Trimmed-mean inflation only just fell below the top of the band at 2.9% in Q1, hardly cause to declare victory, he continued. Wage growth is also likely to persist despite easing inflation, continuing to apply upward pressure, he said. “The mistake that everybody could make now is to cut too much and then find that in two, three quarters, the data wasn't favourable, and then they have to turn around again.”