Perceptions about what the outlook for rates in Australia are have shifted substantially since the last RBA meeting. Even policy setters themselves have changed their position. This has left markets more vulnerable to a surprise at next week’s RBA meeting, and looking for some direction.
There appears to be a growing consensus that Australia’s central bank is done with rate cuts this year. While this is usually good for the underlying currency, the cause of that outlook has some analysts a little worried. Australia’s inflation for Q2 was much hotter than anticipated, but didn’t come along with increased economic growth. That could put the RBA in a tricky situation, and leave the Aussie weaker despite rates staying higher for longer.
The Shift in Outlook
At the end of the last meeting, RBA Governor Michelle Bullock said she wasn’t sure where rates would go, given the macroeconomic uncertainty. This came after the RBA surprised markets twice in a row by showing hesitation to change policy, despite economic models suggesting inflation was slowing down. But, as it turns out, inflation wasn’t slowing down, as evidenced by August CPI rising to 3.0%, the highest since the middle of last year.
Bullock had a more definitive message earlier this week when she presented before Parliament, saying that policy was in a good place. Inflation was still within the target range, albeit at the very top of it. Expressing satisfaction with the current state of the monetary citation didn’t come with warnings about uncertainty, particularly on the trade front. Bullock also suggested that major banks weren’t taking into account the level of macroeconomic risk, which was interpreted as pushback against suggestions from the banks that the RBA should cut rates.
How Markets are Reacting
Markets are now correcting to expect no rate cuts at either the upcoming meeting or the next. Beyond that, the outlook appears too uncertain for traders to place definitive bets. Which turns the focus back to the meeting on Tuesday, and what the economic projections, and particularly what Bullock implies about future rate policy.
Major banks are taking a more cautious approach to expectations, saying that the recent monthly inflation might be an outlier. The RBA still prefers to examine quarterly data to gain a better understanding of the broader trends. In that case, rates could stay on hold for a while, with NAB in particular suggesting that the RBA might not move on rates until well into next year.
The Potential Market Reaction
With the RBA staying on hold and possibly signaling that it will not change policy for several months, the market’s reaction may shift away from monetary policy expectations. That means external issues, such as China’s growth and the US’s monetary policy. If the Fed proceeds with its expected rate cut trajectory, it could go from having slightly higher rates than the RBA to having significantly lower rates than Australia.
Whether that prompts the RBA to ease to prevent the Aussie from becoming too strong and affecting domestic price stability could be an issue raised at the upcoming meeting. That is one of the areas where Bullock could surprise the market by sounding a little more dovish.
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