Market bets the Reserve Bank of Australia will cut interest rates this year have strengthened as global markets shudder at the prospect of a weakening Chinese economy, and economists begin forecasting a rate cut in June.
Market contagion from China and low energy costs are expected to weigh on the bank’s decision, with figures released by Citibank indicating the market has priced in a 100 per cent probability of a cut by the June meeting.
“There’s a lot of noise happening in markets at the moment so that’s put downward pressure on market interest rates,” says Justin Fabo, senior economist at ANZ.
“So that’s kind of spilled over into this RBA pricing as well.”
According to latest interest rate futures pricing from Citigroup, the chances of a cash rate cut to 1.75 per cent at June’s RBA board meeting have jumped to 100 per cent this week, up from 50 per cent late last year.
“This is telling us the risks around monetary policy are still tilted towards further easing rather than tightening,” says Mr Fabo.
“And there’s still a lot of concern about the global backdrop.”
All yields in markets have come down over the last few weeks with concern about China’s outlook and softer data out of the US. This may have prompted people to speculate the US Federal Reserve may not tighten the cash rate as quickly as previously anticipated.
“But things here are looking better on the domestic side, momentum in the economy is still good so the risks are skewed towards later in the year,” says Mr Fabo.
The odds of a reduction in the RBA’s next meeting on February 3, now sit at 20 per cent, compared with 12 per cent on Friday, while for March, the odds have shifted from 36 per cent to 40 per cent.
The RBA surprised markets with a rate cut last February, following a sharp fall in the oil price and a downward revision to the inflation outlook. The most recent cut, from 2.25 per cent to 2 per cent, was announced in May.
HSBC’s Paul Bloxham points out low inflation means the RBA has scope to cut further, though it would hope to maintain market stability.
“The RBA is facing an increasingly uncomfortable trade-off between its desire to lift growth, to keep inflation on target, and the risks that lower interest rates could pose to financial stability,” says Mr Bloxham.
However, Mr Bloxham says bets on an imminent cut could increase if the oil price continues to sink and the consumer price index for December comes in below expectations when published late this month.
The Aussie dollar has traded in a narrow band these last few weeks and Mr Fabo thinks the RBA would be pleased with its current levels around US68¢.
“The RBA wouldn’t be unhappy to see it going down,” he says. “If it’s persistently lower, then great. Because that’s supportive of growth.”