RBA rate decision: Volatility all but assured

Exclusive to The Middle East Online

Edited by Nelly Tawil

Australia’s economy for a majority of the past decade has been subject to a “two-speed: economy. Increasingly that divergence is making it more difficult for the RBA to set policy.

Accelerated annual economic growth has shown itself with Dr. Jekyll’s side of the economy, moving towards a 30 year average of 3.2% as well as a 5.7% drop in unemployment below its mean for the past two decades. Those data in isolation suggested the Reserve Bank of Australia should avoid further interest-rate cuts.

On the other hand Mr. Hyde and his side of the economy shows core inflation has slowed to the weakest pace on record. The country hasn’t seen wage growth at its current rate since the recession, a quarter century ago. The lack of price pressures suggests Australia needs easier monetary policy to combat the same disinflation that’s gripped much of the developed world, undermining capital spending and credit.

A survey of economists and traders believe that there is little chance that Governor Glenn Stevens and his board will cut the record-low btenchmark rate from 1.75% when the announcement is made public on Tuesday at 2:30pm AEDT. It will be the last such call before the scheduled July 2 national election.

Of 24 economists polled in a survey, 23, including Australia’s bog four banks, are of the opinion that rates will remain at 1.75%. Only one – RBC Capital Markets – is forecasting that the crash rate will be reduced to 1.50%.

Financial markets agree with the economic community with crash rate futures putting the probability of another 25 basis point rate being delivered at just 8%.

History is also on the side of a non-move with the RBA changing rates only twice in June in the past two decades.

All attention is expected to shift to the monetary policy statement that will accompany the rate decision, with markets anticipating that the cash rate will be left at 1.75%.

More specifically, markets will be on the lookout for the boards inclusion of an explicit easing bias in the final paragraph of the statement, its presence would serve as a sign that rates are likely to move lower in the period ahead.

In March 2015, having cut rates to a then record-low level of 2.25% in its prior meeting in February, the board stated that “further easing of policy may be appropriate over the period ahead, in order to foster sustainable growth in demand and inflation consistent with the target.”

This was an explicit easing bias, and one that the bank followed through on by cutting rates to a fresh record-low of 2% in May, just two months later.

However, following the second rate cut, the RBA stated in its June 2015 policy statement that “information on economic and financial conditions to be received over the period ahead will inform the Board’s assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target”.

The clear neutral bias signaled to markets that lengthy period of steady rates was likely. The bank subsequently held the cash rate at 2% for the next 12 months.

Its no surprise that so much attention is focused on the final paragraph in Tuesday’s statement, particularly given widespread expectations from economists and markets alike that another rate cut in the second half of the year is a near-certainty.

Should the RBA deliver a clear neutral bias, or even an implicit easing bias, it will create significant market volatility as markets rush to price out the likelihood of a further near-term rate cut being delivered.

Should no explicit easing bias be communicated bonds and some higher-yielding stocks (outside of banks) will likely sell off while the Australian dollar will screech higher in response.

Outside of the final paragraph, markets will closely scrutinise the language the board uses towards outlook for inflation and domestic labour market conditions given its focus on those two areas of late. There’s also likely to be interest on the view offered on the outlook for US interest rates, the Australian dollar and recent developments in the residential property market, particularly in Sydney and Melbourne.