Why September?
Absent a new inflationary shock, central banks’ next moves are likely to be down. We expect the first cut in Australia to occur after the late-September meeting. Here we explain our reasoning behind this timing.
When central banks are in data-dependent mode, financial market pricing will be data-sensitive. Turning points are always like this. The broad narrative will remain the same, but views of timing can shift suddenly. Small data surprises can matter a lot in these circumstances, even if they are mostly noise. We saw an example of this with the noise-affected January Labour Force Survey.
Absent a new inflationary shock, we can be reasonably sure that the next move is down for most central banks across advanced economies. But the question of exactly when is harder to pin down.
For Australia, we have pencilled in the first cut occurring at the late-September Board meeting, followed by another in November. Our thinking on the timing is as follows.
First, this expectation is predicated on the basis that things turn out broadly as we (and the RBA) expect. Inflation continues to decline, while growth remains soft in the first half of the year but does not fall away completely. Unemployment drifts up but does not rise precipitously.
Second, we take as given that the current stance of monetary policy is restrictive. This aligns with the RBA’s view and is supported by various indicators including credit growth and the drag from interest payments on household income. If the RBA maintained restrictive policy on an ongoing basis, growth would slow so much that inflation would undershoot the RBA target and keep falling. The decision to reduce the restrictive stance of policy – and eventually normalise to a more neutral stance – is therefore a question of when, not if.
Third, monetary policy operates with a lag, and the RBA knows this. They will not wait until inflation is already in the target range. They will start moving ahead of this point; Governor Bullock has acknowledged this in Parliamentary testimony. But as the Governor has also pointed out, they will want to wait until they are confident that inflation is declining on the desired trajectory. They want to be sure that inflation will be sustainably back inside the 2–3% target range by end-2025 and around the midpoint of the range by mid-2026.
We have landed on September as our preferred date for the first cut because some key data is released in the lead-up to that meeting. Employment and CPI inflation for the first half of 2024 will be available ahead of the August meeting, but not the crucial wages and national accounts data. These come ahead of the late-September meeting. We expect that these latter releases will show enough of a decline in input cost inflation, a turnaround in productivity and a slowing in growth in labour costs, to convince the RBA that disinflation is sustainably on track.
In the old 11-meeting timetable, it was usually assumed that the months that the RBA published a Statement on Monetary Policy (SMP) – February, May, August and November – were good months to move. In those months, the Board had new inflation data and fresh forecasts, as well as the SMP to explain the decision more expansively. But the inflation data say more about where inflation has been, not where it is going. And as the monthly inflation indicator improves, the information value of the quarterly CPI release diminishes.
Assessing the inflation outlook instead requires information about its drivers, including labour costs, productivity and the balance of demand and supply. The September meeting, along with the other non-SMP meetings, come more into play, because it is ahead of these meetings that wages and national accounts data become available. In addition, the extra value of the SMP for explaining the Board’s decisions is reduced now that the Governor will give a media conference after every meeting. Under the new operating rhythm, all meetings are in principle equally good opportunities to move.
Push and pull risks
In thinking about the risks around this view on timing, the different sources of risk are pulling in opposite directions.
The risks relating to the data would, if realised, tend to pull the date of the first rate cut forward. Over the past few months, the data have tended to be softer than the RBA expected back in November. Further surprises in this direction would start to shift the inflation outlook lower. At some point, this would mean the RBA Board would reach the necessary degree of confidence about the return of inflation to target sooner. It would, however, need a material downside surprise to domestic demand that drags services inflation down faster than currently expected.
A date much sooner than September seems unlikely, however, because of the countervailing risk from the Board’s decision-making and perception of policy risk. These are considerations that would tend to push the date later.
Put simply, the RBA Board is far from being in a hurry to cut the cash rate. They do not want to risk delaying the return of inflation to target. Indeed, they would be happy to get there sooner. Even on the expected trajectory, inflation will have been above target for four years by the time it returns there. The Board is mindful that the longer inflation stays above target, the greater the risk that inflation expectations dislodge. While so far there is no evidence of this happening, it is not a risk the Board would take by moving too quickly. If expectations do shift, it could be hard to return them to target. The Board is also conscious that the peak of the cash rate has been lower here than in some peer economies. So at some level there is less work to do and less of an imperative to get on with it.
There are risks on both sides, but good reason to think these counterbalance each other. At this stage, we see the risks around the September call as balanced rather than tilted one way or another.
Beyond the first 50 (basis points)
We expect the Board to cut twice, in September and November – successive meetings under the new timetable. It is likely to wait and see the effect of these for a while before embarking on further cuts. In particular, it will want to see the effects of the tax cuts in the second half of 2024 on household spending. At this stage, though, we expect further cuts in 2025.
The closer the cash rate returns to something like neutral, the more cautious the Board is likely to be in making further moves. When you are a long way from where you need to be, rapid shifts may be called for. When you are closer to an uncertain destination, it pays to move slowly and wait for more information if possible.
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