Will the RBA cut rates tomorrow?

A rising Australian dollar adds more pressure on RBA to cut rates

Mike King

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Published August 1, 2016 11:17 am AEST

Markets can't decide whether the Reserve Bank of Australia (RBA) will cut the official cash rate tomorrow, with the odds of a cut around 50%, according to various media reports.

Adding further pressure on Australia's central bank will be weak economic data out of the US on Friday. America's growth rate in the June quarter was just 1.2% – about half of what economists had expected. The US dollar promptly dropped against the Aussie dollar – which is now buying 75.9 US cents – its highest level in almost two weeks.

But while markets are undecided, economists are much more certain the RBA will cut the official cash rate from the current level of 1.75%. According to a Bloomberg survey, 20 out of 25 economists expect a rate cut following last week's weak Australian inflation data. The ASX's RBA rate cut indicator suggests a 64% chance of a rate cut to 1.5% tomorrow.

One of the RBA's key roles is to keep inflation in a band between 2 and 3%. Last week it came in at 1.7% for trimmed mean inflation and an even lower 1.3% for weighted index underlying inflation. Those are the lowest levels in 13 years according to Fairfax media.

australia-inflation-cpi — Source: Trading Economics

Headline inflation of 1% is well below the lower band, and even the 0.25% rate cut in May has done virtually nothing to stimulate a rise in inflation.

However, the central bank's 'shadow' board comprised of economists and academics believes the RBA should keep rates on hold – rating a rate rise as a 18% chance and a hold as a 63% probability.

With the Australian dollar rising, inflation not responding to previous stimulus measures and a housing market that is looking more like slowing that booming, the RBA is likely to have little in the way of arguments to not cut rates.

A rate cut of 0.25% to take the official cash rate to 1.5% appears likely. What will be interesting is whether the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) will pass on all or just some of the cut to mortgage customers.

RBA official cash rate 1990 to Jul 2016 — Source: RBA & Author

Will their net interest margins under pressure, they may be disinclined to pass on all of the rate cut to customers.

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