RBA cuts by 25bp, cautious on more cuts given inflation does not return to the 2½% target

After adopting an easing bias at the end of last year, the RBA board cut the cash rate by 25bp from 4.35% to 4.1%, having last raised rates in November 2023.

Governor Bullock said that although the rate cut had been a “consensus” decision, it had not been a “lay down misere” and that there had been an active discussion at the board meeting.

She said the decision was justified because there has been “good progress on inflation”, where the market had anticipated a rate cut after underlying inflation came in lower than the RBA had expected in Q4, partly because of the temporary benefit from government subsidies.

Bullock said that the strongest arguments against a cut were based on the labour market, where she was reluctant to put a number to the NAIRU, even though the Statement on Monetary Policy suggests it is still well above the current 4% unemployment rate.

The governor said that a further cut would depend on an improvement in inflation, spanning easing wages growth, disinflation in market services prices, easing inflation for housing costs, and an improvement in the demand-supply balance in the economy reflecting a recovery in supply, particularly labour productivity.

In terms of the outlook, Bullock highlighted that the staff forecasts now have underlying inflation steady at 2.7% - or above the 2½% target – over the entire forecast horizon, predicated on the technical assumption that the cash rate would fall to 3.5%, which is based on market pricing.

She said not achieving the 2½% target meant that market pricing was “unrealistic”, again stressing that Australia had not raised rates by as much as other countries.

As such, this suggests that the governor is overwriting the staff estimate of the neutral policy rate, where the midpoint of a range of calculations looks to have been revised down from about 3½% to around 3% in the Statement on Monetary Policy.

If this wasn’t the case, then if Bullock thought the neutral rate was actually 3%, then the technical assumption of a 3½% cash rate based on market pricing would still be placing considerable downward pressure on inflation, such that the RBA would forecast a return of inflation to the 2½% target as unemployment continued to rise rather than hold steady at 4¼% as now expected by the staff.

Surprisingly, there was little discussion in the press conference of the immense political pressure place on the RBA by the government.

The government had wanted a rate cut because it has to hold the election by 17 May and the treasurer has brought forward the budget from May to 25 March.

With the RBA cutting rates, the government will likely call an early election and offer more handouts to households given it is doing poorly in the polls and with the monthly financial data suggesting that the budget is tracking better than treasury had forecast.

The next RBA interest rate decision is on 1 April, ahead of the release of the Q1 CPI later that month, which suggests that a further cut during an early election campaign is unlikely, leaving 20 May as the next window for possible RBA action.

Another surprising feature of the both the press conference and the RBA statements was the limited discussion of Trump policies, where Bullock again suggested that the board would take a reactive approach.

On that score, Australia does not trade much with the US, such that the main risk would be trade war fallout from China, which is Australia’s main export market. However, modelling suggests that a lower Australian dollar would play a greater role than interest rates in cushioning Australia any spillover from a weaker Chinese economy.

In terms of the RBA calendar, Governor Bullock and her colleagues testify on monetary policy on Friday, where the political pressure placed on the RBA should feature more prominently.

Upcoming RBA events.
(1) 21 Feb – Governor Bullock and Deputy Governor Hauser testify on the economy;
(2) 5 Mar – Deputy Governor Hauser speaks on the economy; and
(3) 13 Mar – Assistant Governor (financial system) Jones speaks.