Market expectations for tomorrow’s RBA meeting are very low – at close on Monday the OIS market had ~4.5bp of cuts priced in, and I would say that’s too much ‘insurance’ …
Looking further out, however, things are changing.
The biggest change is the sudden drop in export prices. In AUD prices, the RBA’s Index of Commodity prices fell by 4.3% in August, despite the 2.1% decline in the AUDUSD exchange rate.
Due to the fact that Australian export prices are much more volatile than import prices, any terms of trade forecast is basically an export price forecast — note the similarity between the RBA’s terms of trade chart (from the Q3 SOMP) and their commodity price index.
It’s fairly clear just from comparing these two charts that the terms of trade are falling more quickly than the RBA expected. That constitutes a real tightening of monetary conditions, and it is something that the RBA will want to respond to if it is sustained.
Look for the RBA to inch up their dovishness in the September statement, probably by noting the sharp decline in commodity prices (who knew the $100 Iron Ore floor was a trap-door?) …
It still seems most likely that the Bank will await the Q3 CPI data before easing further – but 50bps of easing in Q4 (most probably 25bps in each of Nov and Dec) is starting to look very likely.
The market has ~58bps priced to Dec — given the elevated risks offshore, I expect that the short end can and will price in more.