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Monetary policy to shift from restrictive to stimulative in Australia
Next week sees the RBA Board meet, with most market pundits, ourselves included, expecting a 25bp cut to the official cash rate. At its previous meeting at the start of April, the RBA held rates steady at 4.10%, which it deemed as restrictive, and welcomed partial data pointing to a slowing in inflation. Policy was kept on hold pending further information on the global economy, trends in domestic demand, and the outlook for inflation and the labour market.
The outlook for the global economy has deteriorated since the RBA's April meeting, which was held prior to the announcement of President Trump’s Liberation Day tariffs. The uncertainty and chaos created over the last month and a half has undoubtedly weakened business' investment and hiring plans in the near term, contributing to downgrades to the Consensus Forecasts for most economies, particularly across America and Asia. That said, there was somewhat of a reprieve this week as a trade truce was reached between the US and China. The deal included a reduction in US tariffs on China from 145% to 30%, with Chinese tariffs on US goods also reduced from 125% to 10%, effective for 90 days. The trade deal boosted equity markets, suggesting it was better than analysts expected. If these lower tariffs stick, global growth forecasts may improve, though it is likely growth will be scarred by ongoing trade uncertainty.
The domestic news flow since the last RBA meeting supports the need for policy to be less restrictive. Underlying inflation has slowed to within the target band with services inflation, which had been too high and sticky, also slowing. In terms of domestic demand, the strength of the consumer recovery has been called into question by stalling retail sales volumes in the March quarter. The consumer recovery had been the glimmer of hope in the second half of last year, but it now looks like that recovery had been flattered by Black Friday sales. The pullback in spending in the March quarter suggests a more cautious consumer, who remains price sensitive in a cost-of-living crisis and is choosing to save more of their income gains rather than spend them.
Until this week, the labour market had also showed signs of deteriorating momentum. However, a bumper 89K increase in employment in the month of April reversed prior signs of weaker labour demand. Labour supply also rebounded sharply in April, up 95K due to unseasonally strong population growth and increased workforce participation. With estimates of labour demand and supply so volatile, a better indicator of the underlying strength of the labour market is the unemployment rate. It remained unchanged at 4.1% and has been steady at this level for a year after having moved as low as 3½% in 2022 when labour shortages peaked. Wage data showed an acceleration in annual wage growth to 3.4% in the March quarter from 3.2% in December, though this was driven by one-off factors like government funded increases for aged care and childcare workers rather than stronger underlying momentum. Public sector wage growth accelerated sharply due to State-based enterprise bargaining agreements being delayed from December to March. Underlying wage momentum is stable at around 3¼% down from 4% a year ago, consistent with the signal from the unemployment rate.
While we think the labour market looks broadly balanced in terms of both wages and the unemployment rate, there are risks. Digging a little deeper into the labour market report reveals a fall in average hours worked to lows not seen outside the pandemic-affected numbers of 2020-2022. Falling hours are often a precursor to weaker employment, as it is easier for businesses to reduce hours than headcount. So, while the labour market currently appears balanced, there are downside risks. Combined, developments in the global economy and the domestic data since the last RBA meeting are sufficiently weak for the RBA to be comfortable removing some policy restrictiveness when it meets next week. Most commentators share our view, although forecasts range between a 25bps or 50bp rate cut. The de-escalation in the trade war between the US and China and the unchanged unemployment rate that we have seen this week would likely take a 50bp rate cut in May off the table.
Beyond May though, monetary policy will need to shift into expansionary territory, and that does mean more rate cuts. The domestic economy will improve only gradually, as consumers spend some of the gains in real disposable income from lower taxes and interest rates. But importantly, the economy will remain below trend which implies further downward pressure on inflation, with underlying inflation to move into the lower half of target band later this year. With growth below trend and inflation below the midpoint, the RBA can justify expansionary monetary policy with another two rate cuts in the September quarter, taking the cash rate to 3.35%. Our view has been that the five rate cuts being factored into market pricing over the last month was more reflective of a recessionary environment rather than the below-trend growth environment we are expecting for Australia. This week saw market pricing shift to our view on monetary policy.