RBA to cut next week? - Westpac

Sean Callow, Sydney, at Westpac explained that Australia’s Q2 inflation data wasn’t the game-changer for the RBA and Aussie dollar that Q1 was but reinforced the weakness of price pressures in the economy. 

Key Quotes:

"Headline inflation of 1.0% y/y is a low since 1999 and the annual pace of the average of the core inflation measures held flat at 1.5% y/y.

This is well below the bottom of the RBA’s target band and details of the CPI release suggest there will be no revival in inflation any time soon. 

For instance, the broadest measure of domestic price pressures, non-tradeable inflation, has fallen from above 4.0% y/y in 2013 to just 1.6% y/y in Q2. This is consistent with weak wages growth and shows that Q1 16’s CPI shock was not an aberration. 

This reinforces our economics team’s existing view for the RBA to cut the cash rate to 1.5% at Tuesday’s meeting. Yet some argue that the RBA could save its ammunition, perhaps for November. 

A rate cut is fully priced by November but is a wary 60% or so for next week. This sets up AUD/USD for a volatile day. Clearly our baseline scenario of a rate cut should at least knock AUD lower initially, towards 0.74. 

 Yet we can’t be too bearish right now

Australia’s commodity price basket is at highs dating to May 2014, while EM Asian equities have seen heavy foreign demand this month, as Brexit impact is seen as largely contained to Europe. The FOMC statement this week also lacked the urgency to raise rates that could have fuelled fresh USD/majors gains. Yield spreads should still chip away at AUD/USD multi-month but the damage should be limited near term. 

The Bank of Japan decision is another wild card. Expectations are high for bold action to reinforce what looks like a substantial fiscal package. The initial FX reaction to the announcement might not be the same as the eventual impact on AUD. Even if the BoJ disappoints jittery markets, it is likely that its policy settings will generate AUD demand medium term."