Fed’s bold rate cut leaves RBA as global outlier

The U.S. Federal Reserve has kicked off its easing cycle with a bigger-than-expected 50 basis point interest rate cut, but don’t expect that to prompt an earlier policy shift from the Reserve Bank.  

The Fed move makes the RBA an outlier among global central banks in not having begun to cut rates, with the European Central Bank, Bank of England, Bank of Canada and the RBNZ all having eased in recent months. 

“The decision to cut by 50bp certainly emphasises that the global policy cycle has turned and central banks are increasingly mindful of the downside risks for growth and the labour market, as well as keeping inflation on its path back to target,” says Elliot Clarke, Westpac Head of International Economics.

“But each country needs to proceed based on their individual circumstances,” he adds. 

“Australia’s labour market continues to show strength with employment growth keeping pace with historically elevated population growth and record labour force participation. While that remains the case, inflation risks will remain more probable and thus the RBA’s focus.”

Australia added 47,500 jobs in August, according to official data released on Thursday, keeping the unemployment rate steady at an historically low 4.2 per cent. 

The RBA also makes the point that interest rates here did not rise as high as in other countries in response to the inflation surge that emerged as the world opened up after pandemic lockdowns. Even after this week’s move the US fed funds rate remains higher than the RBA cash rate. 

Money markets still see around an 80 per cent chance that the RBA cuts rates before Christmas, although all the signals coming from the central bank suggest a move is off the table until 2025.  

Uncertain outlook

It’s rare for the Fed to make such a big move, but Chairman Jay Powell was quick to dispel talk that the larger cut – most economists had expected a 0.25 per cent easing – was in response to a growing risk of recession in the world’s biggest economy. 

“The Committee’s statement and Chair Powell’s remarks in the press conference were worded carefully to highlight that the 50bp cut was not a signal of concern about the outlook, but rather a response to inflation slowing near target and the risks to achieving its employment and inflation goals now being ‘roughly in balance’,” Clarke says.

The Fed’s revised forecasts back Powell’s view that economy remains on track. Growth is now seen at 2 per cent per year over 2024-2027 - above the Fed’s ‘longer run’ estimate of trend growth of 1.8 per cent. The Fed also sees unemployment ticking only slightly higher, and inflation not falling below 2 per cent.  

The Fed’s rate-setting committee, the FOMC, projects another 50bp of cuts in 2024 (over two meetings), followed by 100bp of cuts in 2025 and then a final 50bp in 2026. That would leave the fed funds rate at 2.9 per cent – which is consistent with the committee’s estimate of the neutral rate, says Clarke, referring to a notional level that neither stimulates nor restricts economic growth.  

However, there are a broad range of views across individual FOMC members on where rates will be over the longer term, which “speaks to considerable uncertainty over how the balance of risks will evolve,” says Clarke. 

“To us, there is reason to be wary over a further deterioration in conditions and associated risks,” Clarke says. Westpac economists see weaker GDP growth than the Fed in 2025 and 2026, a greater degree of weakness in the labour market, and modestly stronger inflation. 

Reflecting that uncertainty, Westpac economists see the fed funds rate settling at 3.375 per cent by late 2025 -above the Fed’s neutral estimate. Clarke says that the flow of economic data in coming months will be critical in assessing these uncertainties and the implications for the policy outlook. 

To read Elliot’s full note, visit WestpacIQ.