LUCI’S CALL: Rate cuts seen later, but at a faster pace

Luci Ellis
01:30pm November 21 2024

Pedestrians walk past the Reserve Bank of Australia building in Martin Place, Sydney. (Getty)

We have revised our view of the most likely scenario for the path of the RBA’s cash rate, pushing out the start date of the rate-cutting cycle from February to May, but more front-loaded than previously assumed.

We now expect consecutive 0.25 per cent cuts at the RBA’s Board meetings in May and July. That would follow a similar pattern to what we’ve seen from international peers including the Federal Reserve and RBNZ and mark an acceleration from our previous forecast of one cut per quarter. 

We continue to expect the terminal rate to be 3.35 per cent, to be reached by year-end 2025.

Minutes from the latest RBA Board meeting, along with recent public comments from RBA officials, have shifted the balance of probabilities in favour of a later cut. 

The recent sharp increase in consumer sentiment – though still to a below-average level – and ongoing resilience in the labour market will have also added to the case for waiting longer.

The language in the latest meeting noted that the Board “would need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable.” This has been interpreted by market watchers as a signal that the RBA needs to see at least two more quarterly inflation outcomes from here before being confident of their forecasts. 

This is almost certainly how the Board and staff are thinking about the outlook and suggests that they will wait for longer than we previously believed.

In addition, recent RBA communication suggests that they are more comfortable with the later date embedded in recent market pricing than the late-2023 timing implied by the market not so long ago.

That said, we are mindful that things can pivot quite quickly, and that the RBA’s view of the economy looks somewhat more hawkish than we think is warranted.

In the November minutes, the RBA noted that the underlying trimmed mean measure of inflation remained high and was declining more gradually than headline CPI, which has been temporarily dampened by the government’s electricity bill rebates. That was despite the RBA’s economists having shaved their near-term forecast for trimmed mean inflation to 3.4 per cent, from 3.5 per cent, for the year to December 2024.

Our own near-term view is a touch lower still. And if the December quarter outcome turns out to be a little lower than even our own view, it would take the annual rate to 3.2 per cent, just barely above target. In that scenario, one would have to start wondering exactly what they are waiting for. 

Hawkish view

The RBA is also slightly more bullish than we are on the potential for consumption growth to pick up as inflation declines and real incomes recover. Our own view is informed by the relatively subdued response so far to the income boost from the Stage 3 tax cuts. 

We’re also mindful that the strong growth in public demand that is sustaining broader demand will not last forever, and when it does begin to fade the economy could be in for an extended period of lacklustre growth. 

Another area where the RBA could end up revising its view is on the labour market. 

Employment growth has been unexpectedly robust, but it’s important to remember that with labour force participation rates trending up over many decades, employment must run very hard to avoid an increase in the unemployment rate. 

While the unemployment rate has levelled out recently, the underlying trend has been an upward drift for precisely this reason. If employment growth slowed even moderately, things could unravel quite quickly.

Related to this, RBA has (correctly) avoided being too focused on a single number in assessing the level of full employment. But in doing so, it has down-weighted the fact that wages growth has already turned down. Its assessment of full employment could be too hawkish as a result. As we have noted, the RBA already had to downgrade its wages growth forecasts in November. It will need to do so again following the September quarter WPI result.

Taking all these factors together, there’s still a chance the RBA shifts tack and cuts in February. Equally, there’s a risk that upcoming data comes in on the strong side, leading to a further delay in the start of the rate-cut cycle beyond May. 

The longer the RBA Board waits, the faster they will need to move thereafter, as it would then be more likely that they have hesitated too long.

To read Luci's full note, visit WestpacIQ. 
 

Luci Ellis

Luci Ellis is Westpac’s economic spokesperson and is responsible for all of our economic research. She was previously Assistant Governor (Economic) at the Reserve Bank of Australia from December 2016 until October 2023. Prior to that, Luci was Head of Financial Stability Department at the RBA for eight years, spent two years on secondment at the Bank for International Settlements in Basel, Switzerland, and held several other senior positions at the RBA over a three-decade career in central banking. Luci has been a member of the Australian Statistics Advisory Council, the statutory advisory body to the Australian Bureau of Statistics, since November 2015. Luci holds a PhD from the University of New South Wales, a Masters in Economics degree from the Australian National University and a first-class Bachelor of Commerce (Honours) degree from the University of Melbourne.

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