FinX Pulse- RBA cut rates by 25bps

The RBA cut rates again today, signalling greater confidence that inflation will remain in the target range after an initial increase. The trade war is now perceived to be a disinflationary, opening the door to future cuts. Market pricing has adjusted to expect -0.7% of further easing in 2025, while longer-dated bonds are increasingly attractive

FinX Wealth View

• The Reserve Bank Board lowered the cash rate by -0.25% to 3.85% today as widely expected, the first cut since the February meeting.

• The governor pulled up just short of declaring victory at the press conference today. But there was a definite sense of satisfaction that inflation is back within the target band with a high degree of confidence. At the same time, unemployment has remained at very low levels. She also confirmed that the Board would have likely cut by -0.25% solely on the basis of the domestic economic outlook, and she reflected that it was probably time to retire the phrase “narrow path”.

• However, it was also clear that the board faces a new set of challenges as a result of American trade policy, which she described as a “rollercoaster ride” in recent weeks. The last meeting was held on 1st April, the day before the ”Liberation Day” tariff announcements. The view that tariffs represent a disinflationary risk is a significant development from the perception of more balanced price risks just over a month ago.

• Following today's cut, there is some risk that consumer spending picks up more than anticipated. But broadly speaking, market estimates of nearly three more rate cuts this year seem realistic.

• Today's meeting should encourage investors to hold exposure to Australian bond duration risks. Even with deficit concerns in the US, there seems to be little risk of much higher yields ahead. Assuming that trade volatility recedes, carry and roll yield are relatively attractive. At the same time, the RBA is much more likely to respond to downside risks with confident interest rate cuts, allowing longer-dated bond prices to rise.

Details of the announcement:

• In a substantially rewritten statement, the governor said, "Inflation has fallen substantially since the peak in 2022, as higher interest rates have been working to bring aggregate demand and supply closer towards balance. Data on inflation for the March quarter provided further evidence that inflation continues to ease. At 2.9 per cent, annual trimmed mean inflation was below 3 per cent for the first time since 2021 and headline inflation, at 2.4 per cent, remained within the target band of 2–3 per cent. Staff forecasts released today project that while headline inflation is likely to rise over the coming year to around the top of the band as temporary factors unwind, underlying inflation is now expected to be around the midpoint of the 2–3 per cent range throughout much of the forecast period."

• Again highlighting uncertainty, the governor continued, "Uncertainty in the world economy has increased over the past three months and volatility in financial markets rose sharply for a time. While recent announcements on tariffs have resulted in a rebound in financial market prices, there is still considerable uncertainty about the final scope of the tariffs and policy responses in other countries. Geopolitical uncertainties also remain pronounced. These developments are expected to have an adverse effect on global economic activity, particularly if households and firms delay expenditure pending greater clarity on the outlook. This has also contributed to a weaker outlook for growth, employment and inflation in Australia. That said, world trade policy is changing rapidly, thereby making the central forecasts subject to considerable uncertainty.

• "Setting aside overseas developments, private domestic demand appears to have been recovering, real household incomes have picked up and there has been an easing in some measures of financial stress. However, businesses in some sectors continue to report that weakness in demand makes it difficult to pass on cost increases to final prices.

• "At the same time, a range of indicators suggest that labour market conditions remain tight. Employment is continuing to grow, measures of labour underutilisation are at relatively low rates and business surveys and liaison suggest that availability of labour is still a constraint for a range of employers. Looking through quarterly volatility, wages growth has softened over the past year or so but productivity growth has not picked up and growth in unit labour costs remains high.

• [...] "While the central projection is for growth in household consumption to continue to increase as real incomes rise, recent data suggest that the pick-up will be a little slower than was expected three months ago. There is a risk that any pick-up in consumption is even slower than this, resulting in continued subdued growth in aggregate demand and a sharper deterioration in the labour market than currently expected. Alternatively, labour market outcomes may prove stronger than expected, given the signal from a range of leading indicators.

• On monetary policy, she said, "The Board judged that the risks to inflation have become more balanced. Inflation is in the target band and upside risks appear to have diminished as international developments are expected to weigh on the economy. With inflation expected to remain around target, the Board therefore judged that an easing in monetary policy at this meeting was appropriate. The Board assesses that this move will make monetary policy somewhat less restrictive. It nevertheless remains cautious about the outlook, particularly given the heightened level of uncertainty about both aggregate demand and supply. The Board considered a severe downside scenario and noted that monetary policy is well placed to respond decisively to international developments if they were to have material implications for activity and inflation in Australia." [Emphasis Added]

• The RBA produced updated quarterly forecasts in the accompanying Statement On Monetary Policy. Reflecting an assumed cash rate that is -0.25% lower over the horizon than in February, GDP growth was nevertheless revised down on lower household consumption and business investment, while public demand is expected to increase. Unemployment is expected to rise, but only slightly.

• At the press conference, Governor Bullock said that the Reserve Bank now sees the trade war as disinflationary. The expected path of inflation was revised down in both the headline and core series, leading to real wages and real household disposable income growing at a faster rate than three months ago. The savings rate is also expected to rise.

• The decision follows a -0.1% cut to Chinese prime loan rates, as anticipated, and weaker Chinese domestic retail sales (+5.1% yoy) in yesterday's April activity figures. Industrial production (+6.1% yoy) slowed by less than anticipated.

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