Australia’s futures market expects the Reserve Bank of Australia (RBA) to deliver another three 0.25% interest rate cuts this year, which would take the official cash rate down to 3.1%.
The latest Statement of Monetary Policy (SoMP) from the RBA seems to support this notion, given that it significantly lowered its estimate of the neutral cash rate.
The neutral cash rate refers to the estimated interest rate level that would neither stimulate nor restrain demand within the economy.
“When the policy interest rate is low enough, it stimulates demand. And when it is high enough, it restrains demand. Somewhere in the middle, there must be a rate that is neither contractionary nor expansionary”, explained the RBA in 2022.
In November 2024, the RBA estimated the neutral cash rate to be 3.6%, which it revised down to 2.9% in February’s SoMP. The May SoMP, released last week, estimated the neutral rate to be 2.7%.
The chart below, by Kieren Davies from Collabah Capital, shows the downward revisions in the RBA’s estimated neutral rate:
Davies notes that “the RBA estimates of the neutral rate, which are currently derived from seven different approaches, contrast with surveyed economist estimates of the neutral rate, which the RBA now adds to its chart of staff calculations”.
“That is, as of May, the median economist estimate of the neutral rate was unchanged at 3.5%, having held around that level for more than a year now”, as shown in the RBA SoMP chart below:
Regardless, the lower estimated neutral rate suggests that the RBA will be more comfortable cutting the official cash rate below 3.0%, given that such a level will remain mildly contractionary.
This, of course, assumes that underlying inflation continues to fall in line with the RBA’s expectations and remains within the target band of 2% to 3%.
