Tomorrow will in all likelihood see the RBA cut the Cash Rate by 25bps to 4.0%. Futures markets are currently pricing that event as a done deal and have a 50bps cut as a 30% shot.
The inflation data released last week was undoubtedly weak, however our feeling is that the overall economic picture does not support a full 50bps cut tomorrow. The RBA's preferred inflation measure fell to 2.2% in the first quarter which, while low, is hardly deflation. Indeed, were it not for the strength of the A$ and the consequent fall in imported prices, domestic inflation would be close to 3%. The final quarter of last year saw GDP growth slow, but at 2.3% we are certainly not in recession (or anywhere near it). Unemployment remains low at 5.2% with strong jobs data for March.
The RBA will be keen to be seen not to be panicked into an "emergency" 50bps cut. In the face of a slightly below trend economy such a move could be seen as likely to spook markets and further damage the consumer confidence on which the continued recovery depends. As the banks continue to adjust to higher funding costs (in large part due to an increase in the amount of deposit funding which they are attracting with historically high interest rates) do not be surprised to see a portion (perhaps 5bps) of a 25bps cut being retained by the banks. This will inevitably lead to another round of bank bashing from both sides of politics and yet will have been reckoned upon by the RBA (just as they had reckoned on at least some of the Dec cut being withheld).
Further cuts may be required in the coming months but at this stage we believe the RBA will be more than content with a Cash Rate sitting at 4.0% and with the economy performing as it is.