MNI: Higher Inflation Expectations Seen Limiting RBA Easing
MNI (MELBOURNE) - The Reserve Bank of Australia is likely to make only two 25-basis-point rate cuts this year at the most, former officials told MNI, pointing to a rise in 10-year Australian government bond yields in line with higher inflation expectations.
If they anchor around the 3.5% level, the upwards creep of inflation expectations could even lead the RBA to eventually raise the policy rate, said Mariano Kulish, University of Sydney professor and a former RBA senior manager.
“The cash rate will, if inflation is 2.5% and we have a real rate of maybe 0.5-1%, on average should be somewhere between 3.5-4%, so it should eventually converge there,” Kulish said. The RBA's most recent forecasts have underlying inflation at the midpoint of its 2%-3% target range by the end of 2026, which Kulish says is too long a horizon to guide rate setting.
The 10-year ACGB yield has climbed to about 4.5% from Q3’s 3.8%, in line with higher yields across the developed world and reflecting market concerns around the inflationary pressure of U.S. President Donald Trump’s proposed policies. Trump has threatened to impose 60-100% tariffs on China and a blanket tariff of 10-20% on all imported goods.
“If we get a trade war with tariffs going on all over the place, I can't see how that will be conducive to cutting,” said John Simon, adjunct fellow at Macquarie University and head of the economic research department at the RBA between 2014-2024. “I think [the RBA] might be pushing things out for a lot longer than expected.”
Simon expects the RBA to hold off cutting the 4.35% cash rate until the April meeting at the earliest, and thinks that the rise in 10-year yields suggests that the current implied easing cycle low of 3.65% markets have priced in by December could edge higher. (See MNI INTERVIEW: Market Overestimating RBA Feb Rate Cut Chance)
“I think we're talking about one or two cuts here, really, which in the scheme of things is not a huge amount,” Simon told MNI.
WEAKER CURRENCY
Kulish argued the depreciating Australian dollar against the greenback had weakened disinflationary forces, providing another reason for the RBA to limit its rate cuts. “I just find it hard to know where the disinflation force is coming from? Supply doesn't seem to be expanding much, because productivity growth is shockingly bad here. Then you look at demand, it seems employment is running pretty fast."
While AI development could boost future productivity, its impact on Australia's dismal productivity growth was an open question, he continued.
However, Simon noted the weak Australian dollar was driven by U.S. dollar strength and expectations for Australia’s commodities market as China slows, which meant a further decline in economic activity ahead and less inflationary pressure. “I think there is something about interest rate differentials that is part of what's driving the dollar at the moment, but that's just a second-round effect, if you will, of the primary monetary policy consideration,” he added.
The RBA board next meets Feb 17-18.