The ECB, Fed and mostly the BOJ, all did nothing during the recent round of central bank announcements, but hopes are high that the RBA will not disappoint tonight. The Australian central bank is expected by both the market and economists to cut the Daily Cash Rate by 25bps from 1.75% to 1.50% when it announces its decision at 2.30pm AEST.
The OIS market assigns 66.7% probability for a 25bp rate cut to 1.5% by RBA tonight; up from 62.5% last week, and up from 16.8% at the beginning of July. Meanwhile economists see 25 bp cut tonight (20 of 25 forecasts), five see no change.
“Monetary policy is really the only swing instrument - the only game in town,” said Andrew Ticehurst, an interest-rate strategist at Nomura Holdings Inc. in Sydney. “If we are in a world where fiscal policy is constrained because the government is a bit nervous about getting downgraded; if we are in a world where the Australian dollar is going to continue to trade north of fair value because of very low cash rates elsewhere and capital inflows; and if we are getting no policy assistance from those two levers, then monetary policy is all that’s left.”
A good summary of what will be announced tonight comes from Bloomberg's Daniel Kruger who writes that the "RBA will cut, it has no better choice." As he puts it, the economic problems Australia’s facing are familiar across the developed world: falling bond yields, unwanted currency strength, low inflation and the political reality of fiscal restraint.
The recent erratic nature of the global economy suggests Australia needs to seize control of what it can.
The benchmark rate is at 1.75%, so the central bank has some ammunition. Inflation has run below forecasts for the past two quarters, falling to 1% for the April-June period. And with Treasurer Scott Morrison focusing on reducing the budget deficit to help preserve the country’s AAA bond rating, the central bank has little choice but to act.
This meeting will also be the next to last with Glenn Stevens at the helm. With Philip Lowe set to replace him next month, Stevens may want to leave his deputy in the best shape possible.
If the RBA hopes the rate cut alone will weaken its currency, it may be disappointed as the move is mostly priced in. Forecasters surveyed by Bloomberg predict it falls to 71 U.S. cents by year-end.
Some observers point to the country’s 3.1% growth in the first quarter and the frothy housing market and argue that waiting is the smarter course.
However, an overheated home market is now important to the economy. It’s a key buffer as Australia looks to develop alternatives to its reliance on mining exports. The need for this shift is enhanced by China’s efforts to align its growth more with consumer activity and less with exports.
According to RBC strategists led by George Davis, expect the RBA to cut rates 25bps after 2Q CPI confirmed inflation is undershooting target.
- Leading indicators suggest an inflation undershoot will persist for several quarters.
- RBA’s reluctant nature provides some uncertainty; don’t expect an overtly downbeat assessment to be provided in its communication.
- Growth ests, if anything, are likely to be revised higher
Alternatively, analysts at Commerzbank expect the RBA to hold
- Given recently mixed data, supporting commodity prices and the fact that the RBA has a rate meeting every 4 weeks, it can wait a little longer until a clear picture emerges
- As the RBA is likely to underline that a further rate cut remains probable, AUD gains are likely to be limited
- Pricing leaves open risk-reward trade for an RBA hold
- Further out, cut never fully priced by OIS; although market continues to price moderate chance of easing, it also begins pricing slight chance of hike, 0.6%, by July 2017
- Economists’ median calls for 25bp cut in 4Q with chance of another 25bp cut in 2017
How to trade it:
- The risk-reward favors AUD upside if the RBA holds vs potential downside if RBA cuts; AUD/USD range today 0.7562/0.7615, according to Bloomberg analysts
- No cut could see AUD rise within upward-sloping channel to test 2nd standard deviation resistance at 0.7710; it would also lead to a selloff in stocks and rates, sending yields higher and unwinding what moments ago was the tightest spread between Aussie and US 10Y, at just 32 bps, since 2001.
- Widely expected rate cut may see AUD retreat slightly toward 0.7503 1st standard deviation support; additional support at 0.7489 100-DMA may also limit AUD losses
* * *
The RBA is scheduled to release its decision at 2.30pm AEST.