NAB says rate cuts would only be a temporary stimulus

NAB says a rate cut in November and one in February next year would provide only temporary stimulus to the slower parts of the economy and expects that if the RBA were to make these cuts, it would reverse them in 2013.

Before yesterday’s announcement of core inflation up 0.6% and underlying inflation up just 0.3% for the September quarter, the bank had forecast that there would be no rate change until November 2012.

However, it now expects the central bank to cut interest rates next week, with a second cut “likely” in February 2012.

“By then activity will be picking up and employment will be strengthening. Nonetheless, we have tentatively included a February cut in our forecasts very much driven by the near-term inflation outlook – we expect fourth-quarter underlying inflation (due late January) to rise a modest 0.6% with the year ended rate unchanged at 2.5%,” the bank’s economic team led by chief economist Alan Oster says.

In a note explaining its decision to dramatically change its interest rate forecast, NAB says the softer CPI outcome means the RBA can now “relatively safely provide some near-term stimulus to the underperforming interest-sensitive sectors of the economy”.

NAB stresses that the possible November February cuts would act as “temporary stimulus” measures and would not be the start of an “aggressive rate cutting cycle”.

“Market pricing, of around 100 points of cuts, is in our view too aggressive,” NAB says.

Westpac has brought forward its prediction of a rate cut from December to next week explaining that the September quarter figures show that the Australia's inflation picture has been overstated.

“From the Reserve Bank's perspective, this will come as a welcome outcome. Recall that in the August Statement on Monetary Policy the bank, relying on two recent prints of 0.9% quarterly growth for underlying inflation, forecast annual core inflation to print 3.25% for both 2011 and 2012,” says Westpac chief economist Bill Evans.

“We are now confronted with actual core inflation of 2.47% for the year to September 2011 with a benign fourth-quarter estimate of around 0.5% reasonable given the slowdown in the economy. That will allow the bank to lower its inflation forecast for 2011 to 2.5% with a similar outcome likely in 2012,” he adds.

Evans says this “trend” in inflation also provides support for its view that this will not be a one-off cut.

“We have held the view that a total of 100 basis points will eventually be shaved from the cash rate. We reaffirm that view while anticipating that the second cut will come in February after the bank assesses the impact of its first cut on confidence and activity, gathers further evidence on this benign inflation environment and observes further developments in the global economy.

“In line with our consistent view, we expect all these factors will make a very strong case for a further rate cut in February,” Evans says.