Will the RBA stand alone or follow the herd on interest rates?

The Reserve Bank may soon be the last remaining hawk among its central bank peers if the Federal Reserve goes ahead and cuts interest rates at its meeting later this month.

The Reserve Bank may soon be the last remaining hawk among its central bank peers if the Federal Reserve goes ahead and cuts interest rates at its meeting later this month.

After disappointing US manufacturing data this week, Friday’s closely watched release of US non-farm payrolls data had potential to reignite US recession fears that could add to the case for rapid-fire US rate cuts and increase speculation that the RBA will also start cutting rates before long.

It came amid heightened criticism of the RBA from the federal government, with Treasurer Jim Chalmers saying the RBA is “smashing the economy” with its aggressive rate hikes”.

But there was no let-up in the hawkish narrative from RBA governor Michele Bullock.

Australia’s full employment goal is “not served by letting inflation stay above target indefinitely”, Bullock said. Based on the RBA’s economic forecasts the Board “does not expect that it will be in a position to cut rates in the near term”. And while the RBA will “act accordingly” if economic conditions changed, it was “premature to be thinking about rate cuts” in Australia.

That was despite weak economic growth of just 0.2 per cent for a third-consecutive quarter and negative per capita growth for a sixth-consecutive quarter. Annual growth of 1 per cent in the year to June was the lowest – apart from during the Covid-19 pandemic – since the early-1990s recession.

The RBA expects economic growth to rebound to 1.7 per cent by the December quarter and 2.6 per cent by the June quarter of 2025.

But growth was well below potential and its composition was disappointing, economists said.

Private demand fell 0.3 per cent on-quarter, with growth propped up by a 1.4 per cent rise in government spending.

“Although activity likely bottomed out last quarter, the ongoing weakness in private demand raises the risk that the RBA will cut rates sooner rather than later,” Capital Economics economist Abhijit Surya said.

While the tax cuts should boost consumption, it depends on the propensity to spend.

With the household savings rate stalling at a near 17-year low of 0.6 per cent for two straight quarters, households may not be willing to spend as much of the tax cuts as economists expect.

“The upshot is that there is a growing risk that recovery over the second half of the year will continue to disappoint,” Mr Surya said.

“If that is indeed the case, the RBA could well cut rates sooner than we’re currently forecasting.”

Well aware of such risks, the money market continues to stare down the RBA, even as the vast majority of economists don’t expect rate cuts to start until February at the earliest.

The market-implied chance of a rate cut was about 35 per cent by November and 85 per cent by December. More than two rate cuts of 25 basis points were priced in by next April.

Almost 100 basis points of rate cuts were implied by market pricing for August 2025.

Currently at a 12-year high of 4.35 per cent, market pricing implies that the RBA’s cash rate target could be cut to 3.35 per cent over the next 12 months.

While the RBA continues to sound quite hawkish, Goldman Sachs says that’s in stark contrast to key global peers and despite clearly weakening growth and inflation.

The US investment bank points out that Australia’s economic growth has decelerated to its weakest year-over-year pace in 32 years (excluding-Covid), consumer spending has contracted, the unemployment rate has risen 50 basis points in five months, and inflation continues to fall.

“From our perspective, Australian economic conditions are soft and ‘not that different’ to most key global peers,” Goldman Sachs Australian chief economist, Andrew Boak, said.

He expects an RBA easing cycle to come into focus in the coming months despite hawkish RBA “jawboning” and its concerns about productivity, migration policy, and a large positive output gap.

“Overall, we do not find these narratives compelling and caution against overstating their sway with the RBA if – as we expect – the unemployment rate continues to rise over the coming months,” Boak said.

His base case remains for an RBA easing cycle to start in February 2025, but he says the balance of risks is skewed towards an earlier start in late 2024.

Compositionally, activity remains very soft in the parts of the economy most sensitive to restrictive monetary policy, with consumer spending now in outright contraction of 0.2 per cent on-quarter and private demand growth decelerating to just 0.9 per cent on-year.

Despite historically high levels of public-sector employment and spending, the 1 percentage point contribution of public demand to GDP growth over the past year is no larger than that averaged in the five years pre-Covid and should wane alongside a planned consolidation in NDIS spending.

Boak is less positive on the growth outlook after recent downside surprises in consumer spending, household income growth, retail sales, poor consumer sentiment, heightened anxiety about cost-of-living pressures, and households’ preference to pay down debt rather than spend.

While still expecting a rebound in consumer spending from the boost to real household income after $20bn of income tax cuts from 1 July, $6.5bn in electricity subsidies, and falling inflation, Boak has trimmed his 2024 economic growth forecast by 20 basis points to 1.2 per cent.

He also sees important nuances to the three popular macro narratives – ‘falling’ productivity, ‘major’ changes to immigration, and a positive output gap. Moreover, he doesn’t think they will stop the RBA from cutting rates by February 2025 as unemployment rises.

Australia’s headline productivity performance has been poor over recent years.

But part of that likely just reflects difficulties measuring outputs in key “non-market” parts of the economy, like the rapidly expanding health and education sectors.

The recently proposed 270,000 per annum cap on foreign student visas is consistent with a more normal pace of migration and population growth, rather than present a demographic game-changer.

Meanwhile he says the narrowing distribution of strong price pressures in the CPI is encouraging.