MNI RBA WATCH: Board's Dovish Turn Included Debate Of 50bp Cut

The Reserve Bank of Australia board considered a 50-basis-point cut to the 4.1% cash rate before unanimously opting for a 25bp reduction, Governor Michele Bullock told reporters Tuesday, warning that a larger move may be warranted in future depending on the impact of global economic uncertainty.

“The board was of the view that 25bp was the right number on this occasion,” she said, noting the reduction would likely have occurred due to domestic data regardless of the international environment. “With inflation in the band and also employment doing pretty well, we think there is a bit of scope to lower interest rates. And then if you add the international uncertainty… risks have actually balanced up a bit with more of the downside coming into play."

The economy and international environment had changed since February’s 25bp “hawkish” cut, particularly following the introduction of the U.S.’s April 2 tariffs, she said, noting that uncertainty persisted despite a recent decrease in market volatility. “Does that mean that we are headed into a long series of interest rate cuts? I don't know at this point and that's why I think the cautious 25bp cut with a recognition that if we need to move quickly, we can. We've got space.” (See MNI RBA WATCH: Board To Cut 25bp, Shift Focus To Global Risks)

RBA overnight index swaps were flat to 7bp softer across meetings following Tuesday’s reduction, with markets pricing in a 3.1% cash rate by December.

ALTERNATIVE SCENARIOS

The RBA’s Statement on Monetary Policy included alternative scenarios for the first time, and Bullock noted some showed extreme downside risks that could result in a recession. (See chart) "Depending on where we end up on that spectrum, it's possible that there might be more interest rate adjustments," she noted. (See MNI POLICY: RBA's Monetary Policy Dept. To Target Scenarios)

But, while global trade developments are likely to result in deflation for Australia, Bullock cautioned that they could also trigger a supply-side shock similar to that experienced during the pandemic. “We have got inflation down, and we still have employment holding up, but this is not a situation that is going to just be the equilibrium," she warned. "The next year is going to be a really interesting time. It's not the same as earlier shocks. It's a completely different shock, and it's quite possible that the responses, the way we have to set monetary policy, is quite different because the shock is quite different."

LABOUR MARKET LESSONS

Bullock admitted the Reserve’s view of the labour market – long used to justify holding rates at restrictive levels – likely required reassessment, as inflation had fallen despite still-strong employment conditions. “We are open to the idea that we may be overestimating or underestimating full employment,” she continued. “Inflation is continuing to come down, and we're thinking about what that implies.”

However, the RBA’s current view and its business contacts suggested the labour market still posed a key risk that could fuel price pressures. “It's still possible that's indicating that supply and demand have not really come back into balance.”

The RBA's updated SOMP forecast a slightly higher unemployment rate of 4.3% by December, up 10bp from its previous estimate. It also showed a slight improvement to labour productivity, while trimmed-mean inflation is expected to fall to 2.6% by the June quarter – 10bp lower than its forecast in February – based on a 4% cash rate assumption.