RBA Shifts to Neutral Stance on Interest Rates

On Wednesday, Australia’s central bank, RBA, hinted at possible rate cuts. This came in the midst of mounting economic risks and was a notable deviation from its long-standing tightening plan, setting its local currency tumbling.

According to Reserve Bank of Australia (RBA) Governor Philip Lowe’s first public speech this year, the strength of the labor market and inflation will dictate rate movements, which could move in either direction.

“Through much of last year it looked more likely to me that the next move in interest rate would be up than down. But now things are more likely equally balanced,” said Lowe.

This change in tone has caught some investors off-guard because the RBA had steered clear of an easing signal when holding its official cash rate at a record low of 1.50 percent for the 30^th straight month.  Due to this, the Australian dollar plummeted 1.1 percent to a one-week rock bottom of $0.7153.

“We were a bit surprised that the shift to a clearly neutral stance was not communicated yesterday,” said a Sydney-based senior economist who dropped her previous rate hike call for later this year. “Nevertheless, we view a neutral stance as more appropriate and prudent. There is a high degree of uncertainty and risk and that argues for a more patient Reserve Bank.”

An economist from the Commonwealth Bank of Australia also ditched his previous call for tighter policy.

“Indeed, a rate hike looks to be off the cars for the foreseeable future. We have the RBA on hold until late 2020 where a first rate hike would be appropriate if the RBA’s forecast for growth, wages, and inflation come to fruition,” the economist said.

Other banks have also adjusted their policy expectations.

The Federal Reserve has apparently abandoned all plans for interest rate hikes last week due to escalating global growth risks to the world’s top economy. The European Central Bank has also hinted at uncertainty over its plans of policy tightening this year.

Lowe’s speech represented the difficult decisions that policymakers face while they try to oversee market expectations and ease pressure on growth.

“It’s entirely plausible the next move will be up,” the RBA chief stated. “But, it’s also possible that income growth doesn’t pick up, the labor market deteriorates…and business confidence declines.”

According to Lowe, downside risks to the RBA’s outlook include the US-China trade war, global populism, Britain’s convoluted exit from the European Union, political headwinds in the US, and slowing Chinese economy.

Interest rate futures apparently reflected those concerns, pricing in a 56 chance of an RBA rate cut by the end of the year. A full 25-basis-point cut is also seen by mid-2020.

The RBA ultimate outlook is for the economy worth A$1.8 trillion economy to expand 3 percent and 2.75 percent this year and next year, respectively.

That will push jobless rates downward to 4.75 percent from a seven-year low of 5.0 percent now. Wages growth and inflation will gradually pick up over 2020 if that pans out, according to the RBA.

“Their macro forecasts still assume above trend growth, lower unemployment rate and inflation within target.  So, the shift to neutral today shows that they are not entirely confident of those forecasts. We think they will be revised over the course of this year,” an economist said.

Further, Lowe said that “it will be appropriate to lift the cash rate at some point” if jobs growth continued and wages increased more quickly.

On the flip side, the RBA may have to slash cash rates to new record lows if unemployment worsens and inflation remains lukewarm.

“We have the flexibility to do that, if needed,” Lowe said.