The Reserve Bank board on Tuesday said “a further increase in interest rates cannot be ruled out”, but economists and financial traders do not believe them.
“They’re not ready to completely rule out a further rate increase, but I think most people would expect that they won’t have to act on that,” Westpac’s chief economist Luci Ellis told The Business. Until October last year, Dr Ellis was the head of economics at the RBA.
Financial traders agree, with no hint of any rate rises from the current cash rate of 4.35 per cent factored in to market pricing.
The latest rate cut odds, compiled by Bloomberg, imply a one-in-three chance that the Reserve Bank will cut interest rates in May, an 85 per cent chance it will happen by June and, if not, traders are certain there’ll be a rate cut by August.
These prices do not represent exact odds — that certainty of one rate cut by August is skewed by the traders pricing in the slim chance the RBA will cut more than once by then.
Nonetheless, traders have priced in more than two rate cuts before the end of this year.
That implies that traders either expect inflation to come down a lot faster than the RBA does, even after it cut its forecasts on Tuesday, and/or that they think the RBA will start cutting interest rates before inflation falls below the top of the 2-3 per cent target range.
Will the RBA wait for inflation to fall below 3 per cent before cutting?
That was something RBA governor Michele Bullock was quizzed about on Tuesday, but responded with a non-answer.
“Would we need to wait for it to be in the range? Absolutely I think that’s a question that remains to be seen.
“What we need to be convinced is that it’s moved enough and we’re convinced that it’s going to get there and it’s going to be sustainably staying there. I can’t give you a timeline on that.”
The bank’s latest forecasts have its preferred “trimmed mean” measure of inflation falling to 3.6 per cent by June and 3.1 per cent by year’s end.
If the bank’s forecasts are accurate and it wants inflation within its band before it cuts, it would need to wait until at least June 2025, when it forecasts trimmed mean inflation to be 3 per cent, or December that year, when it’s expected to be 2.8 per cent.
But there is a complication with the analysis — it assumes the cash rate will fall twice over the second half of this year, once more in the first half of next year and again before the end of 2025.
However, this is not the RBA telling us what it plans to do with interest rates — it simply needs to plug a cash rate number into its forecasts, so it uses a combination of the market pricing and economist forecasts.
Obviously, if the RBA doesn’t make those rate cuts, inflation would likely come down faster than its forecasts suggest.
So really, the question of when the RBA starts cutting rates depends on how fast it wants to get inflation back to the mid-point of its target range (2.5 per cent), which is what it’s aiming for.
“That’s sort of ideally where we want to see it because, if you’re sort of at the top or bottom, the risks of being pushed out, obviously, are higher,” Ms Bullock explained.
Expectation is for no rate cuts before August
Dr Ellis doesn’t think the RBA will wait until inflation is already below 3 per cent before starting to cut.
“We do think that sometime later this year, probably around September, the RBA will have enough comfort that inflation is coming down quickly enough for their liking to be confident that inflation will return to their 2-3 per cent target,” she told The Business.
“So we think that they’ll be able to reduce the amount of restriction that their policies are creating on the economy.
“They won’t necessarily become stimulatory, I think maybe only one or two rate cuts towards the end of this year — we’ve pencilled in September and November.”
The economists at the other big banks have broadly similar forecasts, which were also unchanged by Tuesday’s RBA communications.
The few analysts who were tipping interest rate cuts as early as May, such as Capital Economics, have generally pushed back their expectations by a few months.
And market pricing did ease somewhat after Tuesday’s RBA communications blitz. May had last week been seen as a 50/50 bet for a rate cut, with June as the near certainty.
In conclusion, the RBA has now got most economists and traders aligned that the first rate cut won’t be until at least August, and there will probably be another before this year ends.
Now all it needs is for the economic data to match its forecasts — something that is notoriously rare.