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The RBA brought a smile to the faces of business owners and mortgage holders this week when it delivered a highly anticipated 25 basis point (bp) rate cut, taking the official cash rate to 4.10% from 4.35%. This was the first time rates had been cut since the pandemic in 2020 and was the last meeting under the existing structure of a single RBA Board. From 1 March, there will be a Board specifically dedicated to the implementation of monetary policy, which will separate the role from governance. The move was almost 90% priced by financial markets, following weaker than expected December quarter trimmed mean inflation, as outlined here (RBA to join the global rate cut party). So, if financial markets thought the rate cut was so certain, why did the Governor describe the move as no “lay down misère”?
The RBA Board reportedly weighed carefully the option of cutting rates versus keeping rates unchanged, replaying discussions held in economics houses across Australia over the last couple of months, including within our Economics & Research team at QIC. Strong cases could be made for both options. In short, the argument in favour of cutting rates was that inflation had slowed and was approaching the target band, meaning there was room for policy to be a little less restrictive. The argument in favour of keeping policy on hold was that, with an unemployment rate sitting at 4%, there was little urgency to cut.
While the Board ultimately leaned in favour of a rate cut, this doesn’t necessarily mean the inflation argument won the day. Instead, another factor was key to this week’s rate cut choice: the desire to maintain good communication with the public. The 2023 RBA Review was highly critical of the Bank’s communication of monetary policy decisions, so this is an area that Governor Bullock has been evolving via the delivery of a post-meeting press conference, a rejuvenated Statement on Monetary Policy (SOMP) and having the Board involved in drafting the post-meeting statement.
With markets pricing a near-certain rate cut, but with no public speeches scheduled, the RBA had no opportunity prior to this week’s Board meeting to dissuade financial markets or the public of the rate cut narrative. This left the RBA in the difficult position of being trapped into delivering a rate cut, regardless of the outcome of the debate over inflation and unemployment.
Having such a line-ball decision on rates with the outcome predetermined meant the job of communicating the RBA view was always going to be difficult, and the Bank’s communication performance this week did not stack up. The combination of heightened uncertainty as articulated in the post meeting statement, upward revisions to inflation forecasts in the SOMP, and the hawkish rhetoric from the press conference that delivered more reasons for a rate hold than a rate cut, left economists and the media wondering why rates had been cut this week.
What was eminently clear from Governor Bullock’s press conference was her guidance that markets are expecting too many rate cuts, a view we share. Prior to the meeting, markets had been pricing 100bps of cuts by mid next year, while QIC’s long-held view has been that only 50bps of cuts would be needed to return the economy to a more sustainable path. In the Governor’s words, “if we cut too much too soon, then we
mightn’t get (inflation) back to the middle of the band”. Support for this statement is found in the SOMP projections, which assume as an input, market pricing for the cash rate path, and generate inflation forecasts that approach 2.7% (rather than the 2.5% midpoint of the band). This provides an important reminder that the SOMP projections should not be viewed as an articulation of the RBA’s central forecasts, but instead, a
scenario of how the economy would evolve given market interest rate expectations.
With the confusion created in RBA messaging following the hawkish rate cut, it was left to Deputy Governor Hauser to deliver with unusual clarity the message that should have been given on Tuesday. Put simply, the RBA’s assessment was that underlying inflation would likely undershoot the midpoint of the target band if policy was left unchanged this year. Hence, a rate cut was needed. This simple messaging could
have avoided much of the confusion created by the mixed messaging of the various communication channels in the immediate aftermath of the Board meeting.
What are the key takeaways from this week’s mis-communication debacle? Financial market participants have been reminded that the SOMP projections are not necessarily the RBA’s central case forecast and should be used with caution. For the RBA, in its quest for better communication, scenario analysis could be a useful tool for explaining their decisions. There could have been little confusion if this week’s decision was explained as follows: “Without rate cuts, inflation will fall too far. With 100bps of rate cuts, inflation won’t slow enough.” This is also easily digestible for the public, who would take away the message that rates might only have a little bit further to fall. So, while it’s great we got a rate cut this week, as we’ve been saying, don’t expect a swathe of rate cuts to be forthcoming.
