A cautious 25bps for the June RBA

I have been putting off writing this post, as the data-flow has been heavy and i figured that it was a close enough call that the RBA would not finally determine their next step until meeting day.

Meeting day is here, and while the RBA will have the benefit of a little more information (especially today’s current account and public demand data for Q1) it seems fairly clear that the outcome will be a 25bps reduction in the RBA’s official policy rate.

The RBA’s decision will reflect a series of judgements that must be made about the global outlook, and how that might alter their domestic inflation forecast – which makes this a fairly low conviction call for me (~70% -25bps)

Looking at their May post meeting release it is clear they have a series of downgrades to put through.

The section on global growth is likely to be revised down, as pretty much every major region has disappointed in the past month. Consistent with this, commodity prices are coming off, as disappointment and political turmoil lowers market expectations of global AD.

These two things have combined to worsen financial market sentiment – though funding markets remain in better shape than Q4’11 (not least for Aussie banks).

There does not appear to be sufficient domestic evidence to materially downgrade their domestic growth assessment. The domestic data has looked a little more two-speedy, and Dep Gov Lowe has noted that the non-mining sector may be allowed to grow more quickly, but i do not think it is a major downgrade. Of course, slower global growth will slow Australian growth a little, but right now i think the subtraction you can be sure of is modest.

With no major downgrade of the domestic demand outlook, and no new information on domestic inflation, the RBA seems similarly unlikely to materially downgrade their inflation outlook. As above, the caveats apply about slower global demand lowering the domestic outlook, however i judge that this channel is modest, and the weaker AUD softens the blow.

The monetary conditions paragraph is where i find the most risk of a 50bps cut. New data suggests to me that the housing market never really stabilised, and equity prices are down heavily – so the wealth channel of easier monetary policy does not appear to be working at all. Still the lower AUD ought to be helping out a bit.

With these revisions, i think that the case for an easing of policy is fairly easy to make. The argument for a 50bps cut rests on a judgement about how Europe is likely to turn out and what impact this is likely to have on Australia. We cannot see it yet.

If Greece remains in the EUR, Spain is bailed out, and Eurobonds appear, perhaps a 3.5% cash rate will do the trick?

I doubt that, but with a bit of a cash splash likely to boost demand starting 1 July, i think the RBA can afford to wait for a little more information before starting a slashing-cycle.

Trading this view is going to be trickier – with the Greek election between the June and July meetings, the OIS market is likely to keep around 5bps of additional easing priced in for some time. Thus, with ~40 bps priced for today, ii would say that the market is more like 50/50 on 25bps v. 50bps this afternoon.