Having finally flipped, Bloxo is now unsure:
* Q3 CPI inflation surprised on the downside, with underlying inflation at 0.3% q-o-q and falling to 2.2% y-o-y, near the bottom edge of the RBA’s 2-3% target band
* This month also saw effective mortgage rates rise, as the major banks lifted their lending rates in the face of higher regulatory capital requirements
* Although growth is rebalancing and business conditions have lifted, we expect low inflation and the major banks’ tightening could see the RBA cut next week
The path of least regret
The RBA has been reluctant to consider cutting its cash rate further. It has made this fairly clear in recent public commentary. Business conditions are improving, employment is picking up, the unemployment rate has stabilised, and GDP growth seems likely to have lifted in Q3, after a weak Q2 print. The lower AUD is providing support for the rebalancing act. The RBA is also concerned about exuberance in the property market.
However, three key things have happened in the past month that mean the RBA may, nonetheless, be forced to cut. First, in response to higher regulatory capital requirements, Australia’s four major banks lifted their mortgage rates by an average of 17.5bp. This, alone, was unlikely to see the RBA consider cutting its cash rate, given concerns about exuberance in the housing market, but it has led to tighter local financial conditions, which may not be desirable at this point in the cycle.
Second, the underlying inflation measures surprised to the downside, with the q-o-q rates falling to 0.3% and the y-o-y rate at 2.2% (market had 2.4%). The RBA was forecasting underlying inflation to lift to 2.5% y-o-y by Q4, which now seems unlikely. Third, the US numbers have been weaker recently, which has seen market pricing suggest that the Fed may not lift its policy rate this year, which is a possible upside risk for the AUD.
Together, these factors strengthen the case for the RBA to cut. The most powerful argument is that inflation is lower than had been expected. This tells us that there is more spare capacity in the economy than previously thought. Although the recent lift in the activity indicators should mean growth lifts and generates some inflation, the bigger risk is undershooting the inflation target, not overshooting. Although we remain optimistic about the rebalancing of growth and expect growth to pick up next year, we think the path of least regret is for the RBA to cut further to ensure than inflation remains on target.
At this point I’m pretty much settled on a hold. Data has been good, the recent commentary has been very hawkish on housing, iron ore hasn’t crashed and there is time to mull everything for a December cut if needed.
