Why an August RBA rate cut isn’t a lay down misere

The RBA has signalled an August rate cut hinges on key data after hawkish communications this week dampened market expectations for an aggressive easing cycle.

Reserve Bank governor Michele Bullock. Picture: Gaye Gerard

Reserve Bank communications didn’t exactly fit the market’s dovish narrative last week.

An August rate cut remains a near certainty as far as traders are concerned, but the RBA made it clear further rate cuts are contingent on quarterly inflation data, due for release on Wednesday.

After relatively hawkish RBA minutes and a speech by RBA governor Michele Bullock last week, money market pricing implies a 97 per cent chance of an August rate cut, versus a 106 per cent chance at the start of last week.

Two rate cuts remained more than fully priced for November, although the chance of three cuts by year-end fell to about 28 per cent from 72 per cent last Monday.

The market now expects the cash rate target — now at 3.85 per cent — to fall to 3.1 per cent by June.

After relatively cautious comments on the inflation outlook and the lack of concern about the economic outlook expressed by Ms Bullock, August isn’t a done deal.

“The monetary policy board clearly remains nervous about inflation and some members want to see actual data to support their expectation that it is still declining towards the 2.5 per cent midpoint of the RBA’s 2-3 per cent target range,” said Westpac chief economist Luci Ellis.

“For this reason, we cannot lock in the cash rate cut in August just yet. We do, however, think it is the most likely outcome, especially if the quarterly inflation numbers come in as we expect.”

Ms Ellis was previously assistant governor (economic) at the Reserve Bank.

Most economists see the cash rate target falling to 3.1 per cent by the end of the March quarter.

Private sector expectations of rate cuts are understandable. After a damaging outbreak of inflation after the pandemic, inflation has fallen fairly consistently for the past two years.

In the March quarter, underlying inflation finally re-entered the 2-3 per cent target band.

Governor Bullock gives a speech at the recent Anika Foundation event in Sydney. Picture: Gaye Gerard

The RBA’s preferred gauge of underlying consumer price inflation — trimmed mean CPI — is expected to keep rising at a 0.7 per cent quarter-on-quarter pace for the June quarter.

Year-on-year inflation is expected to fall to 2.7 per cent from 2.9 per cent in the March quarter.

The range of forecasts in Bloomberg’s survey is heavily skewed to the downside. The high is 0.8 per cent and the low is 0.5 per cent. There’s only one forecast at the high and two at the low.

“A 0.8 per cent quarter-on-quarter increase would present a challenge for the board, given its desire, expressed in the minutes of the July meeting, to wait for the Q2 CPI, along with other data and updated staff forecasts,” said ANZ head of Australian economics Adam Boyton.

The RBA has made it clear, however, an August rate cut is contingent on the CPI data.

CPI data isa less volatile than some data points, but always has potential to surprise.

Last Tuesday’s minutes from the July board meeting said: “All members agreed that, based on the information currently available, the outlook was for underlying inflation to decline further in year-ended terms, warranting some additional reduction in interest rates over time.”

But, the minutes also said the monthly inflation indicators in the June quarter were “marginally higher than were consistent with the staff’s forecast for underlying inflation in the June quarter, growth in private demand in the March quarter had been a little stronger than expected and conditions in the labour market had so far not eased as anticipated”.

In her speech at the Anika Foundation, Ms Bullock said the RBA expects trimmed mean inflation to fall slowly towards 2.5 per cent, but recent data suggested it might not fall as fast as forecast.

“We want to confirm with a full quarterly CPI that we’re still on track to deliver inflation continuing down to the middle of the band over time,” she said.

Significantly, she downplayed the spike in the unemployment rate to a 43-month high of 4.3 per cent in June, saying it wasn’t a “shock” and “more broadly, leading indicators are not pointing to further significant increases in the unemployment rate in the near term”.

Perhaps the most important takeaway from her speech was, even after the unemployment rate rose to 4.3 per cent in June, the labour market remained “tight”.

If that’s the case, it can still generate upward pressure on wages and inflation.

“Our overall assessment at the time of our most recent forecast in May was that there was still some tightness in the labour market, and we expected it to ease a little over the remainder of this year,” Ms Bullock said.

“Firms still report significant difficulties finding labour, even if this constraint has eased somewhat recently. The ratio of vacancies to unemployed people remains high. At the same time, unit labour costs have been increasing strongly.”