MNI: RBA To Consider 50bp Cut In May, But 25bp More Likely

The Reserve Bank of Australia is most likely to stick to a 25-basis-point cut to the 4.1% cash rate at its upcoming May 20 meeting barring renewed financial market deterioriation, however it will consider a 50bp reduction given the U.S. tariff onslaught which is now hitting China in particular, former RBA economists told MNI. 

“Our largest trading partner just got a 125% tariff on all goods to their biggest export market - the relief rally is overdone. We are not out of the woods yet by any stretch,” said Martin Eftimoski, an RBA economist between 2017-2021, adding that a 50bp cut should be on the table. 

Before President Donald Trump rolled back most of the reciprocal tariffs on Wednesday, markets had priced in a 92% chance of a 50bp cut at the May 20 meeting and 140bp of cumulative easing by the end of the year. By Thursday, traders had reduced their expectations, lowering the probability of a 50bp cut to 43% and the total easing forecast to just 115bp by December.

Sean Langcake, head of macroeconomic forecasting at Oxford Economics Australia and a former RBA economist, said calmer bond markets would make the RBA less inclined to intervene. The Trump tariffs will drive significant goods-price deflation over the next two quarters that will allow the Reserve to cut the cash rate 25bp each quarter for the next year, he said. “There's an overhang of capacity in the Chinese economy at present and this is only going to exacerbate it,” he argued.

However, high services inflation and the strong labour market will force the RBA to maintain cautious rhetoric, he added. “Do these trade tensions really move the needle on those issues? Maybe not so much,” he continued, noting that the RBA is likely to see fluctuations in the Australian dollar as temporary rather than lasting. “But the shifting profile of risks around growth is so materially toward the downside at the moment that that would probably outweigh concerns elsewhere."

China will struggle to meet its circa 5% growth target this year, but will stimulate its economy further, which should provide support to the Australian economy, he added. (See MNI: Australian GDP To Weather Tariffs, May Cut Chance Rises)

DOMESTIC CONCERNS

While the market had fully priced in a 3.75% cash rate in May, the Bank will likely point to still elevated Q1 underlying inflation and the strong labour market to justify a more cautious move, noted Mariano Kulish, University of Sydney professor and a former RBA senior manager, adding that a larger reduction could fuel panic.  

The RBA will not immediately be able to determine the wider economic implications of the trade war on the Australian economy and the situation is also changing quickly as Trump makes daily adjustments, he added. 

Australia will face similar supply-side constraints experienced during the pandemic, which will see the Australian dollar depreciate significantly, he continued. “That's inflationary through import prices coupled with a recession,” he argued, suggesting the RBA should hold the cash rate. 

“RBA independence is probably a bit better protected, but this opens up the possibility of a mistake in monetary policy,” he said, pointing to former Governor Philip Lowe’s response to COVID-19 that saw ultra-low interest rates followed by a disorderly reversal.

The RBA would also want to gauge whether Trump’s tariffs drive persistent U.S. inflation, or more limited price hikes, which would give insight into how the Federal Reserve responds, he added. 

DOOMSDAY SCENARIO 

Eftimoski believes the RBA could trim 50bp in May if it believes U.S. capital markets have undergone a significant deterioration.

“There’re three things going on right now. Risk premium is expanding, GDP is being revised down and then the third is the disintegration of the U.S. capital market,” he argued, highlighting the rapid rise in U.S. 10-year yields this week. 

“The first two are not that concerning but the third is. If you're going to buy the dip, are you sure it's a dip?”

A 50bp cut would allow the RBA to communicate its concerns clearly, he said, brushing away concerns such a move would drive panic. "If things are really bad right now and extremely dangerous, is [the RBA] wrong?"