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Gloomy Aussie Rates Traders Win as Inflation Forces RBA Rethink

  • Economist median estimate is for cut to 1.5% at August meeting
  • Forecast changes show central bank willing to do more: CBA

Australian policy makers and economists are finally seeing the domestic economy through the dismal lens interest-rate traders have been using for the past year.

Swaps have been indicating for that long that the Reserve Bank of Australia would cut its benchmark rate at least once if not twice over 12 months, even as most economists saw the central bank sitting at a record-low 2 percent. Traders were proved right May 3 when Governor Glenn Stevens cut the policy rate to 1.75 percent. Now, markets and the majority of economists agree that a move to 1.5 percent is likely with JPMorgan Chase & Co., Commonwealth Bank of Australia and Morgan Stanley more bearish still.

Inflation was “a bit too low” Stevens said Tuesday, adding that and the central bank’s framework of targeting annual consumer-price gains of 2 percent to 3 percent had been a successful tool in deciding policy rates, though it wasn’t rigid. Swaps markets predict the low-point for the Australian benchmark will be about 1.4 percent in April next year, said Jarrod Kerr, a senior rates strategist at Commonwealth Bank, which is calling for a reduction to 1.25 percent by the end of 2016.

“The linkages between international and domestic inflation are a lot stronger these days and global inflation expectations are a lot lower,” Kerr said. “The fact that the RBA capitulated on its forecasts suggests to us that they are willing to do more to get inflation higher. The risk is more toward 1 percent than that they just do another cut and call it quits.”

Morgan Stanley expects the RBA will cut the rate to 1 percent by the middle of 2017 to avoid disinflation and assist with the economy’s transition away from mining, analysts led by Daniel Blake and Chris Nicol wrote a note on Tuesday.

The central bank this month lowered its forecasts for core price growth and said it was unlikely to reach the bottom of the RBA’s target this year and will probably only accelerate sufficiently in the ensuing two years as a disinflationary pulse spreads through the developed world. In undershooting its goal, Australia would join peers from New Zealand to Japan, Sweden and the euro area.

Inflation measures the RBA looks at, which seek to exclude volatile items, dropped to a record in the first quarter, averaging 1.6 percent. The consumer price index has been increasing at a slower than 2 percent annual pace since the third quarter of 2014.

RBA Outlook

The RBA cited low, broad-based inflation as the trigger for it to reduce the cash rate on May 3, its first cut in a year. The governor said Tuesday nobody could control inflation in the “very short-term and you shouldn’t try.”

“We shouldn’t just give up and throw away a framework that’s actually been very successful,” he said.

While Stevens noted policy makers have flexibility, he also emphasized that inflation should have a 2 in front of it, said Daniel Been, a currency strategist at Australia & New Zealand Banking Group Ltd. in Sydney.

The Aussie dollar rose 0.2 percent to 71.96 U.S. cents as of 1:05 p.m. in Sydney Wednesday, paring this month’s decline to 5.4 percent.

Stevens’s “comments suggest that the bank will continue to respond to inflation, but will not slavishly cut rates in response to further disappointment on the inflation front,” Been wrote along with Felicity Emmett and Katie Hill in a research note. “We continue to look for another 25-basis-point cut at the August meeting with the bank on hold following that.”

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