The Reserve Bank of Australia (RBA) raised eyebrows last month when it announced a surprise hold in the cash rate at 3.85%. This decision went against broad expectations and was an example of the central bank’s skittishness in the face of uncertainty regarding inflation’s direction. With each new batch of economic data, reporters and analysts are jumping to conclusions. They are betting on the RBA to soon do an about-face and cut rates to stimulate growth.
The RBA took its decision to hike last month because it was seeking more unequivocal proof. They want to see evidence that inflation is firmly and continuously moving towards their target of 2.5%. Weaker than expected growth and inflation data released so far for the second quarter have raised the specter of economic underperformance. Against this backdrop, RBA-watchers are increasingly speculating that the RBA will need to be less stubbornly cautious. New inflation and jobs reports are sending shockwaves. They will certainly color the central bank’s deliberations in the key August meeting to come.
Market analysts were caught flat-footed and have scrambled to recalibrate their expectations since the July meeting. Traders jumped on the RBA’s surprise hold. Almost immediately, they started to price in a certainty of a rate cut by August, reading the tea leaves for a much more dovish monetary stance. Goldman Sachs analysts now expect one more cut by the end of the year. Even more importantly, this demonstrates a deepening consensus on the need for strong monetary easing.
Economic Data Signals Rate Cut
A combination of strong recent economic data — particularly around inflation and the labour market — has reinforced the RBA’s fears on these fronts. The rate of overall inflation, or headline inflation, slowed to 2.1% in the second quarter, a drop from 2.4% in the first quarter. This was a trend that persisted into June, with headline CPI inflation continuing to moderate down to 1.9% y/y. For a second measure of price pressures, the trimmed mean CPI tumbled to 2.1%, a broad-based easing in inflationary forces throughout the economy.
The employment figures released for June hit like a sledgehammer, giving rise to a serious threat of stagflation. The creation of new jobs increased by just 2,000 jobs, well below the consensus forecast of 20,000 new jobs. That disappointing showing pushed the unemployment rate up. It ticked up to 4.3% in June, 4.1% in May. Additionally, the count of full-time jobs shrank 38,000, though that was more than made up for by a 40,000 gain in the number of part-time jobs.
Hours worked declined by 0.9% month-on-month in June, heralding more bad news to come for the labour market. Yesterday’s tattered data set suggests we’re starting to run out of those lucky punches economic growth continues to desperately throw. This strengthens the argument for a rate cut to strengthen consumer confidence and spending.
Market Reactions and Future Forecasts
As market participants continue to react to the most recent economic indicators, expectations for an RBA rate cut have increased significantly. Analysts at ING have adjusted their forecasts. They pushed back their expected first rate cut to the August meeting, now seeing only one more overall reduction before the year’s end. This new outlook is the result of a cautious optimism regarding the central bank’s balancing act—inflation control without derailing the economy.
In addition, markets seem to be doing a good job of pricing in the expected cut. Fading monetary policy seems most willing to put a floor under the Australian dollar (AUD) on the downside, analysts predict. In fact, several now see a year-end AUD/USD forecast of 0.67. This upward revision reflects investor optimism around a slow recovery bolstered by the support of lower interest rates.
The RBA has an important choice to make in August. The Fed should be sober about what these new data portend. It needs to match its short-run actions with medium- and longer-term inflation goals and evolving macroeconomic tableau. We estimate that a decision to cut rates would still leave room for much-needed relief for more struggling sectors while boosting overall consumer sentiment.