MNI INTERVIEW: Market Overestimating RBA Feb Rate Cut Chance
MNI (MELBOURNE) - The market is overestimating the chance of a February rate reduction by the Reserve Bank of Australia, with economic fundamentals, particularly wage growth, pointing rather to an April 25-basis-point cut to the 4.35% cash rate, a former senior RBA official told MNI.
Wage increases have not fallen fast enough against a background of weak productivity growth to pull down unit labour costs, which are a key factor driving inflation, said John Simon, adjunct fellow at Macquarie University and head of the economic research department at the RBA between 2014-2024.
The market has priced in a 65% chance of a 25bp cut at the Feb 17-18 meeting, but Simon believes other factors, such as political pressure, the incoming board and ongoing confusion around 2023’s RBA Review and its implications for the Reserve’s communications, could be influencing predictions.
“There is a lot of wage pressure still from state and federal governments that have baked in some above-inflation wage rises,” he said, noting the RBA’s productivity growth forecasts were also optimistic.
The RBA board will likely choose to wait for more confirmatory data before cutting the rate, he added, pointing to Q4 wage metrics due Feb 19 and productivity within the National Accounts due March 3. The Reserve might also want to review Q1 CPI, due April 30, before making a move, but this was less necessary, he added.
“If we get CPI slightly stronger than they are forecasting, I think it's entirely feasible that they will hold off until May for the cut,” he added, pointing to Q4 inflation data due Jan 29. Markets have priced in a 4.078% cash rate by the April 1 board meeting. (See MNI INTERVIEW: First Australian Cut By May - Ex-RBA Economist)
NAIRU REVISION
The RBA would need to fundamentally shift its view on the labour market, lowering its non-accelerating inflation rate of unemployment (NAIRU) estimate substantially, in order to be able to cut the cash rate in February, Simon noted, pointing to November’s 3.9% unemployment result.
While the RBA avoids publishing its NAIRU estimate, it has previously pointed to a circa4.5% unemployment level.
However, Simon noted the RBA was already leaning on its estimates to push its NAIRU estimate down to that level, according to recent articles based on freedom of information requests. “Cutting in February, means they'd have to reach the view that we were tracking towards the NAIRU, or balance in labour and product markets, faster than they had anticipated,” he argued. (See MNI: Weak Q4 CPI For Early 2025 RBA Cut, NAIRU Rethink)
But the RBA is increasingly concerned that the extended period of elevated interest rates could be driving hidden problems in the economy, such as strains on household budgets, he added. “They have been emphasising the labour market, but the labour market is really not cooperating with the overall story,’ he added. “They've got themselves tied in knots.”
Simon said the Reserve could rapidly flip to a focus on CPI if it receives a good inflation print in Q4. “If they've got an internal NAIRU estimate, which is really suggesting what is the longer run inflationary forces in this economy, they're in danger of having to reverse course, which is why they emphasise more than one number is required.”
The RBA, however, was a demonstrated slow mover, he said. “If that pattern was continued certainly February seems like it would be earlier than they would have moved traditionally.”