Super-sized rate cuts on horizon after $90 billion sharemarket rout

Home buyers could be delivered a super-sized interest rate cut before Christmas to protect the domestic economy from a US-led recession after the Australian sharemarket suffered its biggest fall since the depths of the pandemic.

As the Reserve Bank board met for the first day of its regular two-day meeting, global equity, bond and currency markets were roiled by fears the world’s biggest economy is slowing much faster than anticipated. The ASX 200 suffered a 3.7 per cent fall, worth $90 billion, following a 2.1 per cent drop last Friday.

The ASX 200 suffered its biggest one-day fall in two years on Monday, prompting markets to predict the Reserve Bank will start cutting rates by year’s end.Credit: Louise Kennerley

The concerns about the US, and what it means for the rest of the global economy, forced financial markets to dramatically change their expectations for the RBA and the official cash rate.

Markets, which until early last Wednesday put the chance of an interest rate rise this week at one-in-four, now believe there is a 12 per cent chance of a rate cut after the RBA’s meeting concludes on Tuesday.

By Christmas, the same markets believe, the Reserve will have cut the cash rate to 4.1 per cent with a 40 per cent chance the bank will end the year with a half-percentage point cut. The cash rate was last at 3.85 per cent in May last year.

A half-percentage point cut in rates would save a person with a $600,000 mortgage about $200 a month on their repayments.

The rout on markets started after lower-than-expected non-farm payroll data in the United States, where the unemployment rate jumped in July to a three-year high of 4.3 per cent. Markets there believe the Federal Reserve will start cutting interest rates next month, starting with half a percentage point.

The Australian dollar had started Monday worth above US65¢ but at one point tumbled to US63.6¢. It recovered slightly to finish afternoon trading around US64¢.

Australian investors were not alone in being hammered. Japan’s Nikkei index lost more than 12 per cent of its value in the biggest single-day drop since 1987, while South Korea’s Kospi shed more than 9 per cent.

Some economists have argued the Reserve Bank, which will release new economic forecasts on Tuesday that are likely to show headline inflation back within the RBA’s 2-3 per cent band by year’s end, should lift interest rates to kill any price pressures in the economy.

But Deloitte Access Economics lead partner Pradeep Philip said any suggestion of an interest rate rise made little sense given the economic headwinds facing the country.

“Increasing the cash rate would just increase the chance of a recession,” he said.

Australian Bureau of Statistics data last week showed inflation at 3.8 per cent for the year to June, exactly in line with the Reserve Bank’s previous forecasts. But there are signs inflation is falling.

The Melbourne Institute’s monthly inflation measure for July, released on Monday, fell to its lowest level in 31 months, down to 2.8 per cent from 3.2 per cent. It’s the first time the institute’s inflation measure has been within the Reserve Banks 2-3 per cent target band since 2021, and well below last week’s official measure of inflation.

Deloitte Access Economics lead partner Pradeep Philip says a further interest rate rise would increase the chances of a recession.Credit: Peter Rae

The institute’s measure of core inflation increased just 0.1 per cent in July. This took the annual rate down from 3 per cent to 2.6 per cent, the slowest pace since April 2022.

Inflation pressures are likely to ease further as the federal government’s energy rebate flows through to households.

“A key reason for the annual fall this month is that a large price increase was observed in July last year due to surging energy prices. The forthcoming energy rebate will further reduce inflation going forward,” it said.

Motorists may also get some relief. The Brent crude oil price has fallen almost 6 per cent over the past four days to $US76.80 a barrel. The Reserve Bank had forecast oil to average $US87 a barrel during the June quarter.

Co-portfolio manager of T. Rowe Price Dynamic Global Bond Strategy, Scott Solomon, said that earlier in the year financial markets put the chance of a pre-Christmas rate rise at 50 per cent. Now markets were fully expecting a rate cut.

He said RBA governor Michele Bullock would find it difficult to reject suggestions that interest rate relief was coming.

“Inflation pressure does appear to be waning and we expect inflation falls into the desired
band about a quarter before current RBA estimates. We are unlikely to see the RBA hikes,
and now a cut is even possible before the year is over,” he said.

“While we don’t expect Governor Bullock to commit to cuts, it’s unlikely she does
much to push back against them. The rest of her global central bank counterparts are
dovish – peer pressure is tough to avoid.”

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