Cash rate could drop sooner and more aggressively than forecast

Aussies are forecast one interest rate cut this year but a more aggressive interest rate easing is looking likely for one big reason.

ANALYSIS

While American and European futures are pricing deep and imminent interest rate relief, local futures are much less dovish.

According to markets, Aussie mortgages will enjoy only one rate cut late this year and not much more in 2025:

There are two main reasons for this.

First, owing to our more strict lockdowns, the Australian cycle lagged the global one by six months.

Second, the Albanese Government unleashed two idiosyncratic inflation shocks not felt elsewhere.

– It acted too slowly on Ukraine War energy profiteering in 2022, embedding inflation into everything.

– Then, it dropped an immigration bomb on a tight housing market and spiked rents for the past eighteen months.

By the end of last year, these two blunders comprised roughly 40 per cent of local inflation.

Despite these mistakes, earlier and more aggressive interest rate easing than is currently priced in futures is likely coming for five reasons:

First, the Australian cycle started later, but it has done a lot of catching down to other weak economies. Households especially are under the pump as real incomes crash.

This will be exacerbated by slowing and marginally falling property prices.

Given households comprise 70 per cent of economic activity, growth follows. Indeed, a per capita recession has been running now for 18 months.

Second, the Albanese Government is working to fix its mistakes with subsidies. These are not sustainable in the long term but do not need to be. So long as they lower the effective inflation rate for rents and utilities, they will register in a weaker CPI.

The Albanese Government is working to fix its mistakes with subsidies. Picture: NCA NewsWire / Luis Enrique Ascui

Third, the Chinese economy is falling apart. Recent news of successful growth targets in 2023 needs to be more accurate. The nominal economy is very weak, and debt deflation is taking hold as its property market crashes.

This has knocked down interest rates, the currency and commodities in oil, gas, coal and green metals markets.

Next will likely be meaningful falls in iron ore, applying another deflationary income drain to Australia.

Fourth, despite worries about the Suez and Panama canals causing inflation, goods prices are still falling globally. Chinese deflation means this has plenty of room to run.

Finally, the Albanese immigration bomb is the process of blowing up working pricing power. Wage growth is about to slow, and with it, services inflation:

Australia is still likely to exit 2024 with higher inflation than other developed markets owing to the immigration-led housing crisis, but we also have a higher inflation target.

The pipeline has enough disinflation to expect earlier and more profound monetary relief for Aussie households than markets expect.

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geopolitics and economics portal. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Originally published as Cash rate could drop sooner and more aggressively than forecast