We have revised our view to an expectation that the RBA will first start cutting rates at the February 2025 meeting, and end at 3.35%. There are risks on both sides of this forecast.
As we noted yesterday, the RBA Governor all but ruled out cutting rates this year. This runs counter to our earlier thinking, that the process of reducing the restrictive stance of policy could start from November.
We have now revised our view to an expectation that the RBA will first start cutting rates at the February 2025 meeting. Consistent with our earlier forecast, the trajectory of rate cuts is expected to be tentative and conservative, at one 25 basis point cut per quarter.
As always, our view on rates is predicated on economic developments turning out broadly in line with our own forecasts. These can differ from the RBA’s view, sometimes materially. Our forecasts for underlying inflation are the same as the RBA’s August forecasts, but we are more pessimistic about consumption growth and less concerned over productivity.
We have also revised the end-point of the cutting phase to 3.35%, from 3.10% previously. For some time, our view has been that the global structure of interest rates will be higher than it was between the Global Financial Crisis and the pandemic. We have now also incorporated the fact that the RBA seems to be putting more weight on its own models of neutral than they did previously. The average of these models is a bit above 3.10%. We think this assessment will shape the Board’s behaviour.
The underlying logic of our framework is that monetary policy works with a lag. If you wait until you are back at target before starting to cut rates from a restrictive point, you have waited too long. So the question is how much evidence policymakers need to see to be convinced that inflation is on track to return to target on the desired timetable.
While our baseline forecast of trimmed mean inflation is essentially identical to the RBA’s, the RBA’s conviction levels around these forecasts are evidently not high enough to consider moving in the short term. The policy logic remains the same, but a data-dependent central bank means that one must also revise the rates view if the data turn out even slightly different from earlier expectations. A similar consideration informed our shift in view back in April.
Another consideration that is specific to the RBA and to the current juncture is that the RBA Review mandated that the RBA adopt and emphasise analytical tools and approaches that it had previously not emphasised. The staff have undertaken a program of model and analytical development to address the Review recommendations, using resources not previously available, for example to assess full employment and the output gap. But these new tools and approaches are new and untested, and it is understandable that, in that situation, the Board would have a higher bar for accumulated evidence before acting.
In particular, we note that all but one of the indicators in the RBA’s full employment indicator checklist has eased between May and August. Yet the Statement on Monetary Policy noted that, “Our overall assessment is that the labour market and broader economy are tighter than previously thought.” Though wages growth has slowed, and undershot the RBA’s earlier forecasts, the RBA’s new framework seems to be relating full employment – and the feasible rate of unemployment – to the difference between wages growth and current productivity growth. This is a departure from traditional models that focus on wages growth itself, or real wages growth.
If not this year, the next realistic opportunity for the RBA Board to begin the process of cutting is at the February meeting. Compared with now, the Board will have access to two more quarterly CPI readings. Importantly, it will also have two new national accounts releases that will confirm that demand growth remains soft and – we believe – that the RBA’s pessimism around near-term productivity growth and unit labour costs is overblown.
It was always going to be the case that the RBA’s strategy to raise rates a bit less than its peers would result in it being among the last to cut, even though disinflation trajectories have not been that different. The RBA is now likely to be even more of an outlier while its peers cut past it. Ordinarily this would have implications for the exchange rate, especially against the United States dollar, given the shift in the rates outlook there. At this stage, though, we think geopolitical and global factors are likely to swamp these small shifts in the rate differential outlook, at least until the end of the year.
We cannot rule out that the RBA ends up keeping the cash rate at current levels for even longer than our revised view. That would occur if inflation surprised on the upside relative to our own forecasts in the lead-up to the February meeting. If that scenario did occur, it is likely that the RBA would end up having to cut a little quicker than we currently assume. In wanting to be sure, the RBA Board is risking getting too far behind the curve, with inflation undershooting the target and unemployment rising further than strictly necessary.
Likewise, we cannot completely rule out that the RBA ends up having to cut this year after all, but only if the economy weakens materially relative to the RBA’s forecasts, and our own. The RBA’s assessment of the real economy and aggregate demand are quite sanguine. Given the weaker US labour market news was released after the RBA’s forecasts were finalised, there would appear to be some downside risks that were not accounted for in those forecasts.
