The RBA has set things up to resume the easing cycle that began in 2011 (I never believed in the whole ‘neutral’ thing … see here). My current view is that the RBA will cut by 50bps in 2015, taking their policy rate to a fresh low of 2% by mid year.
The most likely quarter for the cuts is Q2 – which is long enough to see the impact of the falling terms of trade in the data.
So what happened? The RBA was wrong on growth: compare the above growth forecast chart (from the Q4’14 SOMP), with the below forecast chart (from the Q1’14 SOMP).
The market (and RBA) got off the scent of a rate cut due to firmer than expected growth in early 2014, and now a fresh slowdown has shown that doing so was a mistake.
I do not think that the RBA has given up on their terms of trade view (the above chart is from the Q4’14 SOMP) — despite the following two stark facts about commodity prices:
1/ Real commodity prices – and hence Australia’s terms of trade – have been on a down-trend (ex oil) for over a century (see this paper); and
2/ Every other term-of-trade boom has ended with the terms of trade over-correcting to the down-side (the above is an updated chart from Gov Stevens’ most recent speech).
I honestly think we’ll look back at the first five years of this decade as a period where the both the RBA and Treasury stuffed up royally.
We’ve arrived at the end of terms of trade boom with a massive structural budget deficit, the unemployment rate at decade highs (and trending higher), and with core inflation at ~2%. This is not where you want to start the unwind process – it’s where you want to end it.
Thankfully, the RBA has put cuts back on the agenda with the following comment:
A lower exchange rate is likely to be needed to achieve balanced growth in the economy.
That means that a 2.5% cash rate an AUD TWI at ~68 is not going to get the job done. The RBA has little influence over the AUD, so that means they are considering cutting their policy rate.
Could they cut in February 2015? Sure they could … i don’t think the likely in the last sentence of the RBA’s post-meeting statement gets the weight it ought to …
On present indications, the most prudent course is likely to be a period of stability in interest rates.
This means not just that the most likely outcome is stable rates, but that there is a non-trivial probability that the right course for rates is not stability.
Taken in combination with the above line about 2.5% cash and a 68 TWI being inappropriate, i think it means there is a decent chance (say 40%) that the RBA will cut their policy rate as soon as February 2015.
A 25bps rate cut does basically nothing to the economy, and the RBA doesn’t do fine tuning so if they move i’d assume that they have at least 50bps to do. If I am right that the terms of trade are going back to average, 2% is unlikely to be the cash rate bottom.
Hold onto your hats …