RBA back onto a weak easing bias

The RBA cut by 50bps today, easing their key target for the overnight rate to 3.75%. A big cut normally means that something BIG is going on – and that there is much more to come – however they tried to shut that down in their post-meeting statement.

The line they are running rings true to me. Data had been weaker than they expected so that means that policy had been too tight.

But why cut by 50bps? Because that’s the only way to be sure that they get the rates that matter below the level that prevailed at the start of Q1.

Depending on how you count it, spread widening between the RBA’s policy rate and the variable mortgage rates had increased these rates by 10bps to 15bps since the December meeting.

Given that the retail banks were likely to take 10bps to 15bps of the easing, a 50bps cut was therefore the only way to be sure that the rate firms and households pay would be below the rate they were paying in December.

While the RBA have tried to put up the ‘gone fishing’ signage with their reference to “the appropriate level of borrowing rates”, I do not think they have lost their easing bias. Rather, I would say that they have moved back to a weak easing bias – basically where they were in March.

We will find out more in the SOMP – released on Friday – however my guess is that it will remain the case that the inflation outlook provides scope for easier monetary policy.

My best guess for the Q2 SOMP is that near term GDP will be knocked down – such that the total loss is ~75bps. All things equal, this should mean that the RBA’s unemployment rate forecast rises a further 25bps to 5.75%.

With a wider output gap and lower starting point for CPI, I expect that the entire CPI track will be revised down. It’s very dovish if they hold 2% for Q4’12, but I do not think they will.

More likely, they’ll cut if inflation remains mired at ~50bps per quarter – which, abstracting from the noise, now seems to be where it’s been for the last two years (benefit of lots of hindsight!).

Given this, and my bearish Europe bias, I don’t see anything wrong with current market pricing (a 3% cash rate by the end of this year). The RBA needs to get the rates that matter down another 50bps, and they probably need another 75bps of policy rate cuts to deliver that 50bps of easing to households.