Are the odds against a Melbourne Cup rate cut?
Judging by market pricing, the chances of the Reserve Bank of Australia (RBA) cutting interest rates again at the November policy meeting are now quite low. That’s despite the fact that underlying inflation remains well below the RBA’s 2 to 3% target band, and is likely to remain so when the September quarter inflation results are released later next month.
My sense is market pricing is probably right. While it’s possible, it now seems unlikely the RBA will feel the need to act on Melbourne Cup day. We can all instead just enjoy the race that stops the nation.
What could trigger a rate cut?
Earlier last month, I laid out three scenarios under which the RBA might cut interest rates again by year-end: a further drop in annual underlying inflation to below 1.5%, a rise in the unemployment rate toward 6%, or a move in the $A back toward US80c.
Fast forward a few weeks, and only one of these scenarios seems like a serious risk anytime soon.
As we learnt last week, although employment fell a little in August, the unemployment rate dropped back to only 5.6%.
Unemployment rate outlook
Although the unemployment rate has been broadly steady at around 5.7-5.8% for much of this year, it’s clearly down from levels averaged in 2015. The drop in August suggests its gentle extended downtrend, evident over the past year or so, may have further to run.
Of course, wage growth is still low, and much of the growth in employment of late has been part-time in nature. There’s still likely many Australians working fewer hours than they would like, and many business still too cautious to take on full-time staff.
But the unemployment rate is, at least, heading in the right direction.
Aussie dollar outlook
As for the Australian dollar, it’s currently holding around US75c. It’s been held aloft of late – despite RBA rate cuts – due to the reluctance by the United States Federal Reserve to raise interest rates, and due to the impressive resilience in iron ore prices.
Going forward, there still seems to be more downside than upside to the $A, as the Federal Reserve is likely to raise interest rates at least by December, and ample supplies suggest iron ore prices should also ease somewhat eventually.
The only scenario under which the $A might threaten US80c again, is if China unleashes a massive new round of policy stimulus which pushes up commodity prices further, and/or the Fed steadfastly refuses to raise interest rates even in the face of continued good growth in the US economy. At worst, the $A seems likely to stubbornly hold around current levels which, while not ideal, would be tolerable for the RBA.
That leaves inflation, which remains probably the biggest trigger for a near-term rate cut. To my mind, were the September quarter CPI inflation report in late October to show annual underlying inflation holding at its current rate of 1.5%, it won’t be enough for the RBA to pull the trigger in early November. Rather, as we saw in the March quarter results, we’d need to see a ratcheting down in annual underlying inflation to at least 1.25%, or less.
Such a low inflation result is possible, but probably not likely – as it would require an average quarterly percentage gain in the RBA’s two preferred measures of underlying inflation (the trimmed mean and weighted median) of only around 0.2%, similar to the very low results seen in the March quarter.
If we get results that low, all bets are off and the RBA would be hard pressure to ignore a further worrying step down in inflation, particularly given the RBA’s 2 to 3% medium-term inflation target was only earlier this week affirmed in a new agreement between the new Governor, Phillip Lowe, and Treasurer Scott Morrison.
Low inflation would strengthen the case to have the economy running a lot faster, which might encourage even faster falls in the unemployment rate and lift in very low rate of wage inflation.
Published: Wednesday, September 21, 2016