RBA easing nearing end - RBS

Research Team at RBS, thinks that the RBA may cut interest rates one more time particularly if Q3’16 CPI on October 26 shows underlying inflation remaining well below the central bank’s target range.

Key Quotes

“But we think the RBA is getting closer towards the end of its current easing cycle.

First, the central bank made little changes to its forecasts in its latest Statement on Monetary Policy released after this month’s rate decision. Growth is projected to be 2.53.5% in 2016 and 2017 before accelerating to above potential rates of 3.04.0% in 2018. Underlying inflation is still forecast to remain below target at 1.5% for 2016 before rising into a 1.52.5% range for 2017 and 2018. In contrast, when the RBA cut its cash rate to 1.75% in May it also downgraded its inflation forecasts sharply in May’s Statement on Monetary Policy.

Second, policymakers remain reluctant to ease policy aggressively from current levels. In his last public appearance this month before retiring Governor Stevens spoke about the central bank’s inflation targeting regime.

Further, he warned ‘in the end, we are living in a world in which the ability of monetary policy alone to boost growth sustainably is very likely to be a good deal more limited than we might wish. I think most people can sense this. So we need realism about how much we can expect monetary policy to do, including pushing inflation up quickly. If it were the case that undershooting the target for a period while achieving reasonable growth was the ‘least bad’ option available, the inflation targeting framework has the requisite degree of flexibility to allow such a course.’

This last comment captures the current situation faced by the RBA Australia’s underlying inflation is below the central bank’s 23% target band but the economy is currently growing above 3% and signals policymakers do not feel compelled to keep cutting interest rates simply to mechanically hit their inflation target.

Third, policymakers also appear to expect the Federal Reserve will raise interest rates this year and maintain a tightening bias for US monetary policy. This should help cap the Australian dollar towards the top end of its 2016 range of 0.680.78 range against the US dollar.

We remain cautious on the Australian dollar against the US dollar given financial markets are underpricing the risks of Fed tightening this year. The RBA may be reluctant to keep cutting rates but the search for yield currently driving summer currency markets is unlikely to persist as the next Federal Open Market Committee comes into view in September.

In the week ahead, the RBA will release its August minutes. The meeting record is unlikely to reveal any new formal easing bias just yet. Q2’16 wages and July’s employment report will also be released. The data are important given the central bank’s view that an improving labour market will help push inflation back up to target over the next 12 years.”