MNI: RBA To Cut Cautiously In May, August; Risks To Downside

The Reserve Bank of Australia is currently set to cautiously lower the 4.10% cash rate towards neutral with two 25-basis-point cuts alongside publication of its May and August forecasts, former RBA economists told MNI, cautioning that significant global economic uncertainty implies a risk of further easing.  

Deeper cuts will hinge on how domestic demand holds up amid the slowing global economy, said John Simon, adjunct fellow at Macquarie University and head of the economic research department at the RBA between 2014-2024. “If it turns out that the trade war leads to falling domestic demand, as the uncertainty freezes people in place, then the decision [to cut] will be much easier,” he said, noting recent Q1 CPI data showed continued domestic heat, particularly in services, which grew at 3.7% y/y. 

Australian Bureau of Statistics data this week showed that trimmed mean inflation, the RBA’s preferred measure, fell back into the 2-3% target band at 2.9% y/y, or 0.7% q/q. 

“If the domestic market essentially keeps chugging along, then how do you balance those two sources of inflationary pressure, which are kind of offsetting and leaving you in the middle of the band,” Simon continued, pointing to a potential weakening of goods prices driven by the trade war. “But it's a very unstable equilibrium that we'll be in.” 

The RBA will need to assess the impact on domestic demand as the year progresses and it obtains greater clarity on U.S. tariffs, he added. “There's no reason for [the RBA] to act quickly, in exactly the same way that businesses are going to wait and see, given that it could play out in many different ways in Australia.”

Blair Chapman, senior economist at employment website Seek and a former RBA research economist and lead analyst, agreed the RBA will move cautiously amid heightened uncertainty, but called on the Reserve to provide greater transparency on its view of the optimal cash rate path.

Deputy Governor Andrew Hauser following February's 25bp cut released material that showed the impact of moving versus holding, but the RBA needed to demonstrate the optimal path of the cash rate versus the market assumption, Chapman said. "I imagine it will be easier to get closer to neutral, but I don't think it's a dead certainty that they're going to go all the way there quickly," he argued, pointing to market pricing that expects a 2.97% cash rate by December.

According to market economists, the RBA's most recent models suggest a 2.9% neutral rate, down from its previous 3.5% estimate. (See chart)

FASTER CUTS

James Morley, professor of macroeconomics at the University of Sydney, noted that U.S. trade policies had increased the risk of a major negative shock this year that could drive Australia into recession and lead the RBA to lower the cash rate below neutral. R* could also be lower than previously assumed, due to long-term productivity trends, particularly in the U.S., he added.

Lower import prices will also give the RBA room to cut more quickly toward neutral against a growing sense of downside risk, he said, adding that officials might also see faster cuts as insurance should the economy deteriorate further.

"If their forecast for inflation, they see the shock of uncertainty now means that they actually think inflationary pressures are going to ease off faster, then yes, they would use that as a basis to cut rates. They'll be driven by what they think all of these developments in the global economy imply for their inflation."