Get Ready for the RBA to Cut Rates

It’s the first Tuesday of the month. That means our central bankers get together over expensive coffee brews and fancy cronuts and decide which economic lever they’d like to pull.

The mainstream press are convinced that Reserve Bank of Australia will cut rates today to 1.5%. The ASX RBA rate cut indicator says there’s a 68% chance of a decrease to 1.5%.

I’ve been banging on about an August rate cut to Strategic Intelligence subscribers for a couple of weeks now. Get ready folks, an August cut is coming your way…

Here’s why they’ll do it.

First, there are the usual culprits that will be on the table.

One of those is the Aussie dollar, which, at 75 cents to the US dollar, is currently far higher than the RBA would like it to be. Our currency is stubborn.

When the RBA cut rates to 1.75% in May, the Aussie dipped a little, before rebounding in early June.

The rate cut on 2 May saw the Aussie dive from 76.67 cents (to US dollar) — as shown in the chart below — to a pre-Brexit low of 71.83 cents on 30 May. Since then, the Aussie dollar has continued to strengthen against the greenback.

Aussie Dollar/US Dollar — 1-year chart


Source: Bloomberg
Click to enlarge

Since the RBA May rate cut, the Aussie dollar has continued to rise against a backdrop of Brexit, and a lack of rate movements by the Fed. The Aussie dollar currently sits at 75.36 US cents — a figure that’s frustratingly high for the RBA’s liking.

As Greg Canavan, editor of Crisis & Opportunity, pointed out in our editorial meeting yesterday, the past two or three rate cuts have done little to weaken the Aussie dollar anyway.

A cut today will see a short term fall in the Aussie, but it’s likely it will trade higher once again when the ‘effect’ of the rate cut has worn off.

I’ll bet recent employment data gets a mention in the RBA meeting this month.

 

The June data showed the unemployment rate rising to 5.8%. Only a smidge higher than the previous month of 5.7%. This isn’t at alarming levels, and even with the higher Aussie dollar, these two pieces of data together aren’t enough — at least in sound central banking practices — to justify a rate cut.

Then there’s the property market to consider. While at times of great concern to the RBA, doesn’t seem to bother them at the moment.

The recent July minutes said there’s no cause for concern. On the property market, the statement read:

Liaison had suggested that the outlook for investment was relatively favourable in some commercial property sectors including retail, hotels, student accommodation and aged care. However, non-residential building approvals had remained at relatively low levels over the past year.

In other words, the minutes tell you that, in spite of mainstream headlines blathering on about property prices, the RBA doesn’t see it as an area of concern.

And if they aren’t worried about it, you shouldn’t be either…or so they’d have you believe.

That’s because they have one area they care about: inflation — or rather the lack of it.

The one piece of the puzzle that will be the basis for a rate cut in August is what the recent June quarter consumer price index (CPI) says.

The CPI March quarter figures — released one week before the May Reserve Bank meeting where they cut rates to 1.75% — looked like this:

March quarter 2016 CPI data


Source: ABS
Click to enlarge

At a glance, you can see how prices for everything but health, education, insurance, housing, alcohol and tobacco fell.

The May data showed incredibly ‘weak’ inflation. In central bank parlance, ‘weak’ stands for lacklustre price increases. This 0.2% decline in the main CPI was the biggest quarterly drop since the fourth quarter of 2008.

For central bankers, this persistent price deflation is worrisome.

However, if we go back to the minutes from the RBA’s July meeting, they tell us this:

The Board noted that further information on inflationary pressures, the labour market and housing market activity would be available over the following month and that the staff would provide an update of their forecast ahead of the August Statement on Monetary Policy.

This information would allow the Board to refine its assessment of the outlook for growth and inflation and to make any adjustment to the stand of policy that may be appropriate.

So, what did the June data look like?

June quarter 2016 CPI data


Source: ABS
Click to enlarge

As you can see, prices didn’t fall as much as they did for the March quarter. In fact there was an increase of 0.4%. Bringing the twelve month inflation rate for June to 1%. This quarterly data shows the weakest annual rise in prices since 1999.

Core inflation on the other hand, came to 1.5%. This was marginally above the forecast 1.4%. Most economists prefer core inflation figure, as it’s smoothed out data with the volatile prices removed.

However, even with the June CPI increase, I still believe a rate cut is on the table today.

As I recently explained to subscribers of Strategic Intelligence, no matter what the CPI data says, the RBA will still cut in August:

The thing is, even if there is a tiny uptick in inflation — in my view — there will still be a rate cut in the August meeting.

I said this last week — apologies for repeating myself — but if the CPI falls again, it proves the RBA needs to do more to ‘fight’ inflation.

If the CPI figure is steady, or rises — even a smidgen — it proves what the RBA is doing works, justifying a further rate cut.

Chief analyst at Capital Economics Paul Dales, reiterated the central bank’s commitment to encouraging inflation four days ago, telling the ABC News:

After all, the RBA’s expectation that underlying inflation will be below the 2-3 per cent target range until mid-2018 is based on an assumption that interest rates would fall to 1.5 per cent.

You can argue that a rate cut today leaves nothing left for the new guy to do for the rest of the year. Phillip Lowe takes over from the current governor Glenn Stevens as of September. But I don’t think that’s the case.

I’m confident the cash rate will be at 1% by May next year. But to get there, based on this morning’s current base of 1.75%, that’s three 25 basis cuts away.

In my view, that gives Lowe plenty of things to do.

Will that be our last rate cut for the year? That I’m not 100% certain of at this stage.

We could very well be looking at another rate cut in November this year, or February 2017.

However, today’s rate cut is certainly pointless. It won’t drag the Aussie dollar lower for an extended period of time. It won’t boost employment. I wouldn’t be surprised if it pushed property prices higher.

But the central bank wants higher inflation. And they seem to think that cutting rates to drastic levels will get us there.

Cheers,

Shae Russell,
Editor, Strategic Intelligence

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Since starting out in the financial markets over a decade ago, Shae has extensive experience across various aspects of the industry. Shae cut her teeth in the derivatives industry, teaching clients basic trading techniques with technical analysis.

Joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications, such as Australian Small-Cap Investigator, Gold Stock Trader and Microcap Trader. She’s spent the past two years however, honing her macro analysis skills alongside Jim Rickards, showing Australians how to invest and profit form global macro trends.

Drawing on her extensive experience, Shae is a contributor to Money Morning, and lead editor of sister-publication Markets & Money, where she looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.


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