RBA Views

 

The parlous state of the global economy, now showing up so disconcertingly in a commodity price free-fall, suggests that inflation pressures will be squarely to the down side over the forecast horizon.  As has been evident to most sensible observers for a while, there is a material risk that the RBA will miss it inflation target over the next year or two which means the economy will have under-shot its growth potential.

The RBA “fessed-up” to its misreading of the economy by cutting the cash rate by 50 basis points in May.  To see whether it has fully acknowledged the disinflation risks and global malaise will be revealed with its interest rate decision tomorrow.   Anything less than a 50 basis point cut will indicate that the RBA is still holding on, at least in part, to the mining boom, labour shortage view.  It if cuts 50 basis points, to 3.25%, it will be a recognition of the disinflation risks and will help to support growth and with that, help move inflation away from the undesirable sub-2% pace.  If it cuts less or not at all, there will be a jolt lower in confidence and with it, a downside bias to the inflation outlook,  Whatever it does, there is now a strong probability that the RBA will be cutting official interest rates to around 2.5% by the end of the year as it deals with the disinflation threat.

The market is pricing in a cash rate near 2.0%.  This implies not only a disinflation risk, but also particularly ugly news from the global economy.  While I am not optimistic, a 2.0% cash rate looks a little far fetched… for now at least.