We have revised our view of the most likely scenario for the path of the RBA’s cash rate, pushing out the start date of the rate-cutting cycle from February to May, but more front-loaded than previously assumed.
We have revised our view of the most likely scenario for the path of the RBA’s cash rate, pushing out the start date of the rate-cutting cycle from February to May. Similar to the pattern in some peer economies, we expect the initial moves to be somewhat front-loaded, with consecutive cuts in late May and early July. This is also a change from our previous expectation of a moderate pace of decline of one cut per quarter. We continue to expect the terminal rate to be 3.35%, to be reached by year-end 2025.
As always, our view on the cash rate is predicated on things turning out broadly as we expect, which can differ from the RBA’s own view. An earlier start in February or March is still possible, but it is no longer more likely than a May start date. A later start date is also a risk scenario, if inflation does not decline as the RBA is currently forecasting, let alone our own marginally more dovish expectation. That said, the longer the RBA Board waits, the faster they will need to move thereafter, as it would then be more likely that they have hesitated too long.
The minutes of the RBA Board meetings often provide important colour about the Board’s deliberations, going beyond what is already covered in communications immediately after the meeting. While the post-meeting communication was still broadly in line with our earlier expectation, subsequent public appearances and the minutes now suggest that the balance of probabilities has shifted. The recent sharp increase in consumer sentiment – though still to a below-average level – and ongoing resilience in the labour market will have also tilted the balance of probabilities to waiting longer.
The minutes note that ‘staff forecasts were consistent with the Board’s strategy of aiming to return inflation to target within a reasonable timeframe while preserving as many of the gains in the labour market as possible’. This is important confirmation that, if things turn out as the RBA expects, it will eventually become time to normalise policy. Policy is restrictive, and if it were to stay where it is for an extended period, inflation would undershoot the target sooner or later. The path for interest rates assumed in the forecasts is a technical assumption, and small changes in timing are not that consequential. Even so, recent RBA communication does suggest that they are more comfortable with the later date embedded in recent market pricing than the late-2023 timing implied by market pricing not so long ago.
Market participants and other observers have also pointed to the language in the latest meeting Minutes that the Board ‘would need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable’. This has been interpreted as saying that the RBA needs to see at least two more quarterly CPI (and more importantly, trimmed mean) outcomes from here before being confident of their forecasts. This is almost certainly how the Board and staff are thinking about the outlook. It suggests that they will wait for longer than we previously believed.
We are mindful, though, that things can pivot quite quickly, and that the RBA’s view of the economy looks somewhat more hawkish than we think is warranted.
Recall that as late as February 2022, the RBA was not signalling that it expected to increase the cash rate anytime soon. At the time, then-Governor Lowe was reported as saying, “I think these uncertainties are not going to be resolved quickly. Another couple of CPI’s would be good to see.” Yet it raised rates in May of that year. When the facts change – it became apparent that wages growth had actually picked up at last – you have to change your mind.
Recall also that the RBNZ pivoted quickly this year, too. Only a couple of months before the first cut in August, it was looking like it was going to stay on hold for all of 2024.
The language of the minutes emphasised that trimmed mean inflation was high and declining more gradually than the rebates-affected headline CPI. No mention was made that their near-term forecast for trimmed mean inflation over the year to December 2024 was shaved down slightly to 3.4% from 3.5% in the August round, as was the end-2025 forecast. This was characterised as being ‘little changed’. It does raise the question of what constitutes a ‘good quarter’ for inflation. Indeed, our own near-term view is a touch lower still. And if the December quarter outcome turns out to be a little lower than even our own view, it would take the annual rate to 3.2%, just barely above target. In that scenario, one would have to start wondering exactly what they are waiting for.
As the minutes highlighted, the RBA’s forecasts hang crucially on a relatively bullish view of the potential for consumption growth to pick up as inflation declines and real incomes recover. Our own view incorporates a more modest recovery, noting the relatively subdued response so far to the income boost from the Stage 3 tax cuts. And while public demand (and non-market employment) is sustaining some demand growth for now, this will not last forever. When the outsized growth in this area does eventually fade, it will take time for other sectors to recover in compensation. Australia could end up with an extended period of lacklustre growth.
Another area where the RBA could end up revising its view is on the labour market. Employment growth has been unexpectedly robust. It is important to remember that, with labour force participation rates trending up over many decades, employment has to run very hard to avoid an increase in the unemployment rate. While the unemployment rate has levelled out recently, the underlying trend has been an upward drift for precisely this reason. If employment growth slowed even moderately, things could unravel quite quickly.
Related to this, RBA has (correctly) avoided being too focused on a single number in assessing full employment. But in doing so, it has down-weighted the fact that wages growth has already turned down. Its assessment of the level of full employment could be too hawkish as a result. As we noted last week, the RBA already had to downgrade its wages growth forecasts in the November round. It will need to do so again following the September quarter WPI result.
Taking all these factors together, we assess the risks around our revised view of the rates outlook as two-sided.
