MNI: RBA To Cut In May, Neutral To Guide Further Easing

The Reserve Bank of Australia is likely to reduce its 4.10% cash rate another by 25 basis points at the May 19-20 meeting, but further easing in 2025 will be guided by its neutral rate estimates, former staff and independent economists tell MNI, noting policymakers must do more to communicate the Bank’s reaction function. 

“If [Q1 underlying CPI] comes in below what their forecast is, gets close to the band, or maybe even at the top end, then they will cut again [in May],” said James Morley, professor of macroeconomics at the University of Sydney. “On the real side, if they see things changing in the labour market, or GDP growth comes in even weaker, then they might cut even if inflation is just cracking their forecast.” 

The RBA’s hawkish February cut was likely a reaction to the Reserve’s use of the Taylor Rule, which sets rates according to output and inflation, and not a "fine-tuning" tweak, following Q4’s 0.5% q/q result, Morley added. The neutral rate was likely around 3%, he said. (See MNI RBA WATCH: Board Delivers Hawkish 25BP Cut)

“The language they used made it sound like fine tuning, but to me sounds like they're trying to convey their reaction function, the Taylor rule that they're following," he noted.

While the RBA’s uncertainty over the neutral rate will likely drive a cautious approach, the cash rate could finish 2025 somewhat lower than the market’s 3.5% expectation, he added. (See chart)

COMMS ISSUES 

Peter Tulip, chief economist at the Centre for Independent Studies and a former senior research manager at the RBA, criticised the Reserve’s communications and called on the Bank to detail its reaction function in a more quantitative way. 

“It's all verbal, and so when they say there'll be a modest response or a big response, no one really knows what that means,” he added. 

Pointing to Q4 inflation, which had offset labour market strength and created the case for a cut, Tulip said the bank needed to be clearer about the factors that mattered. “This big market overreaction was clear evidence of miscommunication,” Tulip noted, pointing to the market’s over-90% pricing ahead of February’s cut. He said the surety of market pricing showed the RBA’s reaction function was poorly understood. 

“The closely related problem is that the bank is presenting forecasts that it says are unrealistic,” he added, pointing to the Bank’s market path-based cash rate assumption that showed underlying inflation hovering 20bp above its 2.5% target. 

Tulip believes the bank will cut once more should Q1 inflation fall in line with expectations in May, but further easing this year was unlikely based on the Bank’s forecasts. 

FALSE START

Sean Langcake, head of macroeconomic forecasting at BIS Oxford Economics and a former RBA economist, said February’s cut was unusual compared to the start of previous easing cycles due to still-high services inflation and low unemployment. However, holding the cash rate would have wrong-footed the market and invited criticism over the RBA's communications, he added.

Langcake doubts the 4.10% cash rate is restrictive and likely sits closer to the top end of the Bank’s neutral rate estimates. 

“Rates have been in the neighbourhood of where they are now for a long time, and yet it's still an economy that's facing capacity constraints,” he argued. “But that story works well with some of their estimates and not well with others. They don't really tell us what goes into cooking up each one.” 

Langcake warned the RBA could be laying the groundwork for just one isolated cut, pointing to Governor Michele Bullock’s hawkish tone post February's meeting. The Bank's forecasts may have tilted more hawkish to downplay market expectations of further easing, he continued. "Because if you took those forecasts completely at face value, you'd be thinking, there's only one more cut to come this year,” he noted.