MNI: Markets Overplaying End-of-Year RBA Cut - Ex-Economists

MNI (MELBOURNE) - Financial markets have mispriced the chance of a 25 basis point rate cut by the end of the year, with price and unit labour cost data within Q2’s National Accounts vindicating the Reserve Bank of Australia’s recently hawkish tone, former RBA economists told MNI, adding the cash rate is likely to hold at 4.35% until early 2025.  

RBA overnight index swaps market have priced in a 4.10% cash rate by the end of the year, however, traders have probably overestimated the influence of a U.S. Federal Reserve September cut, said Sean Langcake, head of macroeconomic forecasting at BIS Oxford Economics and a former RBA economist.

“[A Fed cut] doesn't change what the RBA will do, it doesn’t change domestic inflation pressures,” he added.  “I think certainly with the commentary, there's a bias toward action, whether that's a hike or a cut, when really the reality often is [the RBA] probably thinks it’s roughly in the right spot, so they're not going to do anything.”

RBA VINDICATED

The RBA board ruled out a 2024 rate cut and the National Accounts, despite showing weak GDP growth and household spending, supported the Reserve’s view that domestically-driven inflation remained a problem, Langcake added. 

Labour productivity, measured as GDP per hour worked, fell by 0.8% over the June quarter, following Q1’s revised 0.1% decline, while the Domestic Final Demand deflator, which measures domestic prices, lifted 0.9% in Q2, or 4.2% y/y – higher than the 3.8% CPI quarterly read, data from the Australian Bureau of Statistics showed Wednesday. 

“The RBA will continue to be hawkish – this kind of productivity performance is not consistent with the [2-3%] inflation target,” he noted. “As long as they keep seeing that, it's going to be hard for them to cut.”

Paul Ryan, now senior economist at REA Group, noted the particularly weak productivity data will drive the Reserve to reassess its forecasts, adding that there was a 5% chance the board could still hike over the course of the next six meetings. (See MNI POLICY: RBA Relief As Productivity Weakness Unwinds)

The RBA’s view on productivity growth has been for it to revert to more pre-Covid norms, he said.

“Potentially growth will get revised down maybe a touch over the next half year but what will happen to inflation forecasts? I don't see them changing too much, which puts the RBA in an awkward position. Does it want to raise rates in an already weak economy? That might be what it has to do."

The Reserve could stomach a slight upside surprise to inflation, but a significant deviation could warrant action, he added. The central bank had consistently noted the cash rate did not follow U.S. rate moves, Ryan added. “The RBA has always told the story that local, domestic market conditions matter more than I think markets encapsulate,” he argued. However, he conceded a Fed cut driven by lower global inflation could still put some downward pressure on Australian prices. 

FISCAL DRIVERS

Langcake noted the main driver of demand in the economy was public spending and that real interest rates were hardly restrictive, estimating the current cash rate is likely about 50-70 basis points above neutral. 

The National Accounts showed public demand accounted for 0.4% of GDP growth, up 20bp, while private demand fell 40bp to -0.2%.  

Higher construction, retail and labour costs will eventually peak, which will begin to put greater pressure on inflation, but this will take time and the RBA will unlikely change its strategy this late in the cycle, Langcake argued.