RBA to cut by 25 bps. Retain optionality for the future (even if there are more cuts to come)

Stephen Miller

The March quarter consumer price index (CPI) was a good enough result for a 25 basis point (bp) policy rate cut at the Reserve Bank of Australia (RBA) meeting on 19 – 20 May, but that is about it.

The trimmed-mean result at 2.7 per cent was bang on the RBA projection. Meanwhile, the April labour force report revealed a labour market in rude good health with the unemployment rate at 4.1 per cent, amid record high participation rates and robust employment growth. Wage growth remains reasonable, albeit that continued sluggish productivity growth creates questions around the sustainability of current levels.

So, with inflation within the target two to three per cent band, and there being a reasonable prospect (but not the certainty) of some further decline, and with policy still in “restrictive” territory, the most judicious course would seem a further 25 bp decline in the policy rate to 3.85 per cent.

Recall that in the wake of the April policy rate cut, RBA Governor, Michele Bullock, was at pains to quash any notion that cut was necessarily the start of a sequence of rate cuts at successive RBA meetings. That might eventuate, but as in April, the Governor this time around will also wish (rightly in my view) to give herself and the Board maximum optionality for future RBA Board meetings.

In that sense, and given a robust labour market and reasonable wage growth, expectations in some quarters for a 50 bp policy rate cut seem “a bridge way too far”.

That said, the upending of the global trade system occasioned by the Trump Administration’s tariff agenda will constitute severe headwinds for the global economy in the period ahead. That is the case despite the President walking back some elements of the “Liberation Day” announcements. That walking back only mitigates the damage relative to the baseline of no change. It does not eradicate the damage. In that context a global recession by year-end remains a reasonable prospect.

That prospect, combined with perhaps some “over-achievement” on inflation relative to the current RBA projection, may mean that we do get successive policy rate reductions at future RBA Board meetings, despite the understandable unwillingness of the Governor to pre-commit to such a path.

That unwillingness reflects, inter alia, RBA Board concerns regarding the response of firms’ pricing decisions and wage outcomes in the face of weak productivity. That is, elevated unit labour cost growth remains a brake on any willingness to open the door to policy rate cuts at future meetings.

Nevertheless, Australia’s eschewal of retaliatory tariff measures may give the RBA a less complicated path to attacking the any egregiously adverse consequences of a global trade war.

The absence of retaliatory measures will mean a mitigation domestically of the inflation part of the global “stagflation-lite” scenario, allowing the RBA to cut rates and, if need be, to cut aggressively to forestall the inevitable decline in economic growth.

So, the RBA will definitely cut the policy rate in May. Further, given the prospect of the RBA “over-achieving” on inflation, combined with a reasonable prospect of a global recession, it could well be that the policy rate has a “2” handle by year-end, although that is more speculative conjecture than central case, and were it to occur, far from that being good news, it will reflect an economy in some difficulty.

In any case, don’t expect the Governor to entertain any speculative conjecture in her press conference.