Timing and tactics
Nothing the RBA will learn in the next five weeks makes it worth waiting until the August meeting to cut the cash rate. Beyond the next move, things are less clear-cut and – as for other economies – increasingly driven by domestic considerations not global common shocks.
Boiled down to its essence, the RBA’s near-term policy decision rests on whether the five weeks after next week’s meeting would change anything. If not, just get on with it next week. This was the rationale for our change of call last week.
The story is less clear-cut further out. Front-loading further rate cuts would imply a fundamentally different view of the economy than the RBA has recently articulated.
The Australian situation is part of a broader shift whereby domestic variation now dominates global common shocks as a determinant of monetary policy setting. This implies that short-run shifts in bond pricing and exchange rates can be expected, sometimes running counter to expected longer-run trends.
One of my longstanding bosses at the RBA (he knows who he is) had a superlative ability to get to the essence of an issue. When all those around him were debating the minutiae, he would bring it all together, often with a pithy question.
Monetary policy is complicated. The world is complex and uncertain. In the end, though, all that complexity needs to be boiled down to a decision about what to do with the cash rate. Sometimes it helps to channel my old boss and frame the issue as a pithy question. Back in May, the question was: could you really write a Board paper with a compelling case to hold? Having written a few in my time, it was clear that the answer to this question is “no”. That judgement solidified the call for a rate cut in May.
This time around, the question boils down to, “could you front a media conference and explain why you decided to wait another five weeks to cut rates, when it was just a choice between now and August?” Again, the answer is likely to be “no”. To be fair, there are arguments to wait (for quarterly CPI, new forecasts and so on). That is why we do not regard a cut in July as a shoo-in. Given how sensitive the RBA has been to arguments about lingering inflation pressures, it could be that the case to wait wins the day in the Board room.
The arguments to wait are not compelling, though, so we do not think that case should win the day. Nothing the RBA will learn in the subsequent five weeks will change the decision to cut. And explaining to the assembled mainstream media that you hesitated because (in essence) unemployment is “too low” and employment growth is “too strong” to do so will not land well with that audience.
Inflation is in the target range, with downwards momentum now evident. Ordinarily, the monthly CPI indicator should not tip the balance; the RBA’s own language does suggest they put far more weight on the full suite of quarterly data. As highlighted last week, though, a large enough downside surprise in one month can still tell you enough about the quarterly result that even a small upward surprise to the month-three data will not change. Sometimes, as it did with the May data, it can confirm the suspected downwards momentum. Key components of domestic inflation – rents, home-building, insurance and personal services – all surprised on the downside. Some of these components are still only measured quarterly and so are locked in for the June quarter read.
Likewise, another monthly labour force release and the last-ever retail sales number will not change the current view on the economy. More information is usually better, but not always by enough to be worth waiting for.
A decision to cut in July is one of timing and tactics, not whether to cut at all. The RBA has shown itself willing to “surprise the market” when the question is whether to move or not. The May 2023 hike was a good example of this. But if the question is now or in five weeks’ time, the juice is not worth the squeeze. Just get on with it.
Tactics versus strategy
The story changes when we consider the path after the next cut. Backing up a July cut with another in August seems like more of a stretch than shifting an obvious August cut to an almost-as-obvious July cut. To do so would require a qualitatively different view of the economy and the inflation outlook than the RBA has recently articulated.
This is why we suggested last week that the RBA’s post-meeting communication will be quite circumspect. One possible way to frame their message might be that, having now cut three times, it is prudent to wait a few months see how lower rates are flowing through the economy before deciding how much more is needed. This would leave open the possibility of further cuts but push back on an August timing. Given current market pricing, some would regard such messaging as “hawkish”.
There is a tension here, though. With inflation now clearly inside the target range and the forward view still heading down, it is questionable why monetary policy needs to be restrictive at all now. Given monetary policy affects the economy with a lag, leaving policy restrictive when inflation is already so close to target risks pushing it below the target midpoint and perhaps below the target range altogether.
The RBA’s read of the labour market is important here. The offset to the risk of an inflation undershoot is its view that the labour market is still tighter than is consistent with full employment. Documents released under Freedom of Information showed that, early this year, the RBA was clearly considering whether this assessment was too pessimistic, and a lower unemployment rate was sustainable. However, the work was clearly unfinished at the time of release and was pushing back on alternative hypotheses. The careful, evidence-based approach the RBA staff bring to their work means that the RBA does not come to a view lightly. Nor does it change its view lightly – or quickly. (This is not a criticism!)
For this reason, while we expect further rate cuts from here, their timing will depend on the RBA’s evolving view of the economy. Until we hear more about how the RBA’s view of the inflation outlook is shifting, we see little reason to move the timing of those subsequent rate cuts forward. (That means we currently expect the next cut later this year, in November, and two more in the first half of 2026). Such a shift could still be needed down the track, however.
And we all (don’t) go down together
The Australian situation is part of a broader shift in strategies for monetary policy setting. In recent years, the story has all been about the common global inflation shock following the pandemic and then Russia’s invasion of Ukraine. Different countries were exposed to different extents; consider the inflation differential between Germany and Switzerland in recent years because of their differing exposures to hydrocarbon-based energy prices. By and large, though, most countries faced the same challenge: first, to get inflation down; and second, to remove the restrictive stance of monetary policy once it was clear that inflation would turn to target and stay there. The story is no longer so uniform, though. Even the supposedly common shock of the Trump administration’s tariff policy is playing out differently in different regions.
As Westpac Economics colleague Illiana Jain highlighted in her write-up of the Sintra Panel this week, as circumstances diverge across economies, so too do the strategies of monetary policymakers. This implies that short-run shifts in bond pricing and exchange rates can be expected. In some cases, this could run counter to expected longer-run trends.
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