The Reserve Bank announced kept the benchmark rates unchanged at 2.25% at this month’s meeting. There was much theatre around the announcement with the AUD spiking 30 seconds before the announcement and then rallying up to 1% after the announcement. The rates markets were pricing in a ~60% chance of a rate cut. Where to from here?
Macquarie believes that with the cash rate already at historically low levels, it appears that the RBA is conserving its policy ammunition. A 25bp cut in isolation is relatively unusual. And in Macquarie's view it is unlikely to be enough to achieve the necessary weakness in the currency - in isolation. If the Fed sticks to Macquarie's expected timetable of a June interest rate rise, the RBA may 'get out of jail free'. But the risks of Fed delay, and the full impacts of ECB's QE yet to emerge, suggest to Macquarie that this may not be the case.
A great deal of concern has been expressed around upward pressure on house prices from further rate cuts. Given the implementation of macro prudential policy tools (and other regulatory changes), Macquarie are less concerned about current short-run price dynamics. Rather, Macquarie think there may be a fundamental case for the RBA to potentially conserve some rate cut ammunition for the period where the surge in residential supply currently approved or under construction hits the market.
Macquarie remain of the view that the extent of cuts in 2015 is more likely to be 50-100bp, than 25-50bp. Currency depreciation, particularly over the past few months, has merely matched declines in commodity prices. The actions of other central banks over coming weeks, and months, could hinder the A$'s decline. And Macquarie has previously highlighted a range of structural challenges that may hinder the economy's response to a weaker exchange rate. These argue for a lower than currently anticipated exchange rate, for longer, potentially being needed to catalyse balanced growth in the economy. Whilst some commodity prices have stabilised, the declines we have seen still mean an exchange rate below US$0.75 is likely to be needed. A 2.25% cash rate is not, in Macquarie's view, going to be enough to get the job done.
Goldman Sachs has a similar view. GS articulated that the RBA left rates unchanged despite evidence of a clear weakening in the tone of current domestic economic data and a sharp deterioration in prospective investment in 2015-16. In a relatively short statement that is notable more in prior comments that were removed than in new information conveyed, the RBA did reinforce a strong easing bias that suggests that in the absence of a sharp decline in A$ or a strong recovery in the economic data that further easing is likely in coming months. The pause by the RBA appears more tactical rather than suggestive of the end of a new easing cycle. The RBA will likely await further announcements by APRA to tighten up macro-prudential policy in an effort to cool Sydney house prices, before easing further. Ultimately GS believe the economic activity will be poor and the underlying inflation data will be sufficiently low to warrant additional monetary easing. From GS’s perspective, it is really only a question of April or May for the next easing. Indeed, GS expect underlying inflation to move well below the RBA's target zone upon the April 22 release of the CPI data and as such GS believe the RBA will likely ease in April rather than being reactive to the data in May. GS continue to look for the cash rate to move to 1.75% in 2015, although the final cut may be in 3Q15 rather than 2Q15, as GS currently forecast.
The fact that the RBA is concerned about house prices, commercial property prices and equities indicates that whilst there are stretched valuations in these asset classes and the fact that lower interest rates are squeezing un natural buyers of these risk assets to inflate returns, the RBA may be on hold for longer than Macquarie and Goldman's currently forecast.