Interest rate cut delivered, expect another in Q3: HSBC's Paul Bloxham

GUEST OBSERVER

The RBA cut its cash rate by 25bps to a new record low of 1.75 percent, as we expected. 

Market pricing was 45:55 just prior to the meeting and 12 of 27 economists in the Bloomberg survey expected a cut. The motivation for the cut was the sharply lower than expected Q1 CPI print.

The RBA remained generally upbeat about the rebalancing of the economy, although they suggested that growth would probably run at a 'more moderate pace' this year. In short, although growth is solid, it has been insufficient to keep inflation on target. Continued low global inflation and rates also contributed to today's decision to cut. Given the extent of the downside surprise on Q1 CPI inflation we expect that the RBA will need to follow up with a further cut (pencilled in for Q3). Importantly, today's cut is likely to make any further monetary policy moves unlikely before the 2 July election.

Facts

The RBA cut its cash rate by 25bps to 1.75 percent, as expected by 12 of 27 economists in the Bloomberg survey (including HSBC). Immediately prior to the announcement the market was pricing in a 45 percent chance of a cut.

Implications

The RBA has, for some time now, been reluctant to consider cutting its cash rate further. But last week's sharply weaker than expected Q1 CPI print clearly changed that view. Today's cut reflects that inflationary pressures are materially weaker than expected.

Although growth remains solid, which has supported business conditions and seen the unemployment rate edge lower, it has been insufficient to lift inflation. This partly reflects that the rebalancing of growth following the mining investment boom has seen growth run at a below trend pace for three years so far. Today's statement also suggested that the RBA sees growth moderating a little in 2016. As the central bank noted in today’s statement, growth ‘is continuing in 2016, though probably at a more moderate pace’. And despite the lower unemployment rate, ‘labour market indicators have been more mixed of late.’ This may reflect the fact that the most recent declines in unemployment have had as much to do with lower participation as job gains.

The RBA also noted that risks from the housing market have abated over the past year. In our view, the booming housing market was a factor that contributed to keeping the RBA on hold late last year, even though the Q3 CPI print was also on the low side. Tightened lending standards and slower house price inflation have helped to allow the RBA room to lower rates further, without the risk of overinflating the housing market.

Low global inflation and interest rates were also a contributor to today's decision to cut. Last week's very low Q1 CPI print provides some evidence that Australia is finally being sucked into the centre of gravity of the low global rates and inflation environment. With this in mind, today's cut was needed to ensure that the AUD did not rise significantly from here, which could have weighed further on growth and inflation.

Cutting today, rather than waiting, also has the added advantage that a further RBA move prior to or just after the 2 July election is now unlikely, which helps to keep the central bank out of the way of the political process.

Nonetheless, given the scale of the downside surprise to Q1 inflation, and the continued low global inflation environment, we doubt that today's rate cut will be enough to get underlying inflation back on track. We expect the RBA may need to deliver a further 25bp cut in Q3, probably in August, following the Q2 CPI print.

Paul Bloxham is chief economist (ANZ) for HSBC. Daniel Smith is economist. They can be contacted here.