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Tuesday sees the first of the RBA Board meetings for the year and therefore the first opportunity for the Bank to move on interest rates…if it wants to. There has been much speculation in recent days suggesting that the Bank might be looking to cut the Cash Rate by 25bps (to 2.25%); its first move since August 2013. A lot of this speculation has been driven by an article from respected “RBA-watcher” Terry McCrann suggesting that a cut (with more to come) was virtually a done deal next week. The futures market is currently pricing a 25bps cut next week at about a 64% chance and has fully priced in a 25bps cut by Mar; and a full 50bps by mid-year.
So what’s the likelihood of the Bank moving from its previously stated policy of “a period of stability in interest rates“?
The RBA is tasked with regulating interest rates so as to “to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve these statutory objectives, the Bank has an ‘inflation target’ and seeks to keep consumer price inflation in the economy to 2–3 per cent, on average, over the medium term.” So with those objectives in mind, let’s look at how we’re tracking.
Inflation data released earlier this week (and confirmed by sluggish Producer Price Indexs today) clearly show us that inflation is not a problem at the moment. Headline CPI is currently running at just +1.7% (below the stated target range). However, as we pointed out in our previous post, it is the “core” inflation measures that the RBA will be focused on; here we see average core inflation of 2.25%. This is within the target range but has fallen from 2.6% a year ago and from 2.75% just 6 months earlier.
The Bank’s aim is to maintain inflation within its 2-3% target range “over the medium term”. If we consider the average quarterly core inflation data for the past year we see inflation at 2.54%, this is actually up from 2.45% by the same measure a year earlier. Clearly inflation is not a concern. However, we would suggest that the idea that inflation is collapsing and therefore demands a rate cut is flawed.
When we consider employment the picture is also confusing. The unemployment rate has risen, although perhaps not as sharply as some have suggested. A year ago the Trend unemployment rate stood at 5.9%, today it is 6.2%. However, as the graphs below make clear, employment growth (whilst hardly stellar on a pre-GFC basis) is actually reasonably healthy. It is very early days, but it also appears that the Trend unemployment rate may be topping out. Whether the employment picture warrants a cut from the RBA looks very marginal at best.
If we define the “economic prosperity” element of the RBA’s objectives as meaning Australian GDP then the graph below makes it clear that economic growth has slowed. However, annual growth remains at 2.7% which is only slightly lower than the 15 year average of 3.0%. Again, the data is hardly definitive in support of a rate cut.
On balance, and given that we are certainly not as au fait with RBA thinking as many in the markets in Sydney, we believe that the data does not support an urgent need for the RBA to begin cutting rates at this stage. If there is pressure to do so from within the Board then we think it far more likely that the decision announcement next Tuesday will start to make some effort to shift expectations away from the “period of stability” rhetoric with a view to potential cuts in coming months.
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February 1st, 2015 at 8:54 am
Great post, Pete, and I can understand your logic. However, I think a cut is very likely in coming months. The bond market is going nuts and the cash rate is now above some long term bond rates (see http://www.rba.gov.au/statistics/tables/index.html#interest-rates). This suggests very low inflation expectations and offers the Bank scope to cut in an effort to boost confidence and investment.
February 1st, 2015 at 9:13 am
Thanks Gene. Agree that there is certainly scope for a cut in coming months if the RBA feel the need. I’m just not convinced that they will want to move as soon as next week without giving the markets guidance that a move away from the “period of stability” is on the cards (and I don’t believe that Terry was that guidance!). Thanks for the comment.