Westpac tips June rate cut and cash rate to fall to 2% by March 2014

Westpac chief economist Bill Evans is tipping the cash rate to fall by 25 basis points to 2.5% in June and then to eventually bottom out at 2% by the first quarter of 2014.

Following the June rate cut, he expects two further rate cuts will be required in the December quarter of this year and March quarter of next year.

"That would see the cash rate bottom out at 2% from its current 2.75%. Having driven rates down to that level we expect rates to remain on hold through the remainder of 2014," he says.

Evans was the first major economist to correctly tip the cash rate to fall to 2.75%.

"There are ample precedents for a May/June move. Over the last 10 years the Bank has moved rates on four occasions in May with two of those occasions being followed up in June," says Evans in his latest market commentary. 

Evans expects that from June, the RBA will be "patient to assess the impact on domestic demand of the low rates".

"However by year's end it will become clear that further stimulus will be required to offset the impact of a softening world economy while the response to the low rates in the domestic economy will be disappointing," he says.

Evans says the really key new developments over the last few weeks have been "evidence of an even lower than expected trajectory for inflation and, as pointed out in this note, a Reserve Bank that is clearly open to further action". 

"Given this scenario we think that the most likely policy option is a follow up rate cut in June of 25 basis points which will be implemented for the same reasons as we have seen today complemented by further evidence of softening confidence and weak business investment. 

"We have also always argued that our assessment of the global economy is more subdued than the consensus. The IMF is expecting 4% world growth in 2014 – we are closer to 3%.

"For Australia's terms of trade, the peak to trough decline in the 2011–12 period was 17%, while we forecast a 2013–14 decline in the region of 10%. We have long maintained that from a world growth perspective, 2014 will feel like 2012," he says.

Furthermore, Evans says the "threat of a disruptive event in Europe remains ever present". 

"The US story does not convince us. We confidently expect that the US Federal Reserve will persist with its quantitative easing policy through most of 2014. 

"China has already begun the process of recalibrating its monetary and real estate policy settings and the support it received from the export sector in the first quarter is already receding.

"Indian domestic demand is flagging badly and the required policy support has not been adequate. Japan is something of a bright spot, but its gross acceleration will far exceed the net from a global growth perspective as it takes back market share," he says.  

"Our specific profile for the Australian dollar, which had incorporated a steady cash rate of 2.75% (with downside risks) and a softening world economy, saw the Australian dollar back at US$0.97 by June next year, partially due to a gradual narrowing of the overvaluation premium. 

"With our lower RBA rate profile there is some modest room for further moderation in the fair value of the Australian dollar with our June 2014 target being lowered to US$ 0.96. However, the key to a more significant fall in the Australian dollar is a more marked reduction in that over valuation premium – something that lies essentially outside the RBA's influence," he says.