RBA Preview: what to expect from this week’s RBA meeting

When is the RBA meeting?

This month’s RBA meeting will occur on Tuesday, May the 7^th at 2.30PM (EAST).

The economic data that matters:

What are the key themes to watch out of this RBA meeting?

1. Inflation:

It was the abysmal CPI figure released in April that set the stage for this RBA meeting. Following a global theme, annualized price growth in Australian is a paltry 1.3 per cent, according to that print. This figure is well below the RBA’s 2-3% target band for inflation; and raises serious concerns about aggregate demand and general growth conditions in the Australian economy. Traditionally, the RBA’s core mandate has been price stability, and it’s the absence of this that is leading many pundits to call for a cut to interest rates at this week’s RBA meeting.

2. Growth and jobs:

For many months, the RBA has remained steadfast in its assessment of the Australian economy. According to the central bank, spare capacity exists in the economy, but this should be absorbed over time as economic growth improves and the labour market continues to tighten. In recent months, this views has become somewhat dubious. Although the jobs market has demonstrated signs of strength, with the unemployment spending time below 5.0% at stages, economic growth has trended lower, with the last GDP print suggesting the Australian economy grew at a below trend 2.3% in the 12 month’s prior to that release.

3. Households and consumption:

The source of the weakness in the Australian economy is easy enough to identify. Consumer demand has softened over the course of several years, as higher levels of private debt, slower wages growth, and a fall in household constrain confidence and spending. Australia’s household debt levels sit amongst the highest in the developed world, at around 190% of income. Wages growth has proven insufficient to sustain consumption, with wages barely outstripping inflation for several years. And demonstrating how Australian’s have funded their consumption, the household savings ratio is below 2 per cent and trending lower.

4. Property prices

Australia’s property market has been in freefall for several years. Amid the risk of a slowing domestic economy, concerns exist that this dynamic could be exacerbated, due to the potential emergence of a negative feedback loop of falling household wealth, softer consumption, and weaker economic growth. Interest rate cut advocates broadly suggest that this is justification for the RBA to cut interest rates. Conversely, opponents of RBA rate cuts suggest that this would be akin to a kick-of-the-can down the road, with the benefits of such an approach curtailed by the law of diminishing returns.

5. Australian election

The Australian people will go to the polls eleven days after the RBA’s policy meeting. Although the RBA, like most central banks, claims its independence from politics, many amongst the punditry have suggested that one key reason the RBA will not interest rates at this meeting is to avoid becoming a political lightening rod in the lead-up to the Federal election. And there is a small precedent cited to support this argument: the RBA cut interest rates weeks before a Federal election in 2007, and were widely criticized at the time for impacting the political narrative before that poll.

What is the market expecting at this RBA meeting?

Interest rate traders are currently implying an almost 50 per cent chance that the RBA will cut interest rates by 25 basis-points at this meeting. Effectively, that means that 12 points of cuts are already priced into the market. Given this is the case, markets are veritably split as to whether the RBA will move rates, or not, at this meeting. Irrespective, it must be said that for market participants, it is a matter of when and not if the RBA cut interest rates: implied probabilities suggest that there will be two cuts from the RBA before the end of 2019.

How could the RBA meeting impact the financial markets?

1. Australian Dollar

Because only half of the possible 25 basis points of interest rate cuts are priced into the market, the Australian Dollar will move whether the RBA cuts rates, or leaves them on hold. To put it simply: the market will have to price in an extra 13 basis points of cuts into the market; or price out the 12 basis points of that are currently in the market. For this reason, volatility around the RBA meeting is high, at around 22 per cent, implying a 72 point move in the AUD/USD.

2. Interest rate markets

Interest rate traders will be carefully monitoring the RBA’s commentary and guidance, to induce what the central bank may do with interest rates beyond just this meeting. In the lead-in to this meeting, rates traders are expecting 2 cuts before the end of 2019, with the first fully priced into the market for July. It’s often said that interest rate cuts are like cockroaches: if you see one, there’ll likely be more around. A cut this time will lead to questions of when the next may come; while a hold will heighten speculation of when markets will see the first.

3. ASX200

The Australian share market has been sensitive to speculation in interest rate markets, broadly benefitting from the expectation of rate cuts from the RBA. A fall in the yields in long-term government bonds has improved valuations across Australian equities, courtesy of a more risk-friendly discount factor. In addition, income chasers have flowed into stocks in non-cyclical sectors, in search for more attractive yields than what can be found in fixed income or cash. Hence, a rate cut, if it were to occur, would likely lift the ASX, while steady rates would lead to a pullback in the market.