Bank modelling has RBA cutting rates to 1 per cent

The central bank’s decision to lower the official cash rate could signal a new downward trend.

Announcing the rate cut on Tuesday, RBA governor Glenn Stevens said that lowering the cash rate is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the RBA's target.

Mr Stevens said available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak.

As a result, he said, the unemployment rate has gradually moved higher over the past year.

While the RBA expects the fall in energy prices to offer significant support to consumer spending, the decline in the terms of trade is reducing income growth.

“Overall, the Bank's assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected,” Mr Stevens said.

With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate, he said.

Credit Suisse Australian Investment Strategy noted that the RBA gave no hints as to whether it would cut rates further.

“But we know from recent speeches that the Reserve Bank would not cut once if it did not see the case for multiple rate cuts," Credit Suisse said. 

“We remain of the view that more rate cuts are coming – it is just a question of how deep the easing cycle needs to be.

“Our model of the cash rate suggests that a rate closer to 1 per cent is currently appropriate, because of subdued private sector confidence, rising unemployment, excessive household gearing and low inflation.

“But a cut in the cash rate to 1 per cent would surely indicate a hard landing, consistent with defensive positioning.”

The RBA noted that credit growth picked up to moderate rates in 2014, with stronger growth in lending to investors in housing assets.

“Dwelling prices have continued to rise strongly in Sydney, though trends have been more varied in a number of other cities over recent months,” Mr Stevens said.

“The Bank is working with other regulators to assess and contain economic risks that may arise from the housing market,” he said.

Credit Suisse believes there is limited evidence to date of credit market stresses emerging to contribute to a hard landing.

“Credit spreads have widened by only 10-20 basis points over the past few months,” it said. “But the proof in the pudding is whether the banks are willing to pass on the cuts in full.

“Also, what is worrisome is the global trend towards deflation.

“Should this trend continue unabated, credit spreads could widen further, and commodity prices could resume their decline. These developments would add to the case for easing, over and above domestic slowdown considerations.”

Westpac’s forecast, released on 4 December 2014, included not only a 25 basis point cut this week but a follow-up move of 25 basis points next month.

“Our reasoning is that the Bank would not have disturbed such a long period of interest rate stability for just one move,” Westpac chief economist Bill Evans said.

Meanwhile, AMP Capital chief economist Shane Oliver expects the cash rate to fall to 2 per cent in the months ahead.

Mr Oliver highlighted that the main risk in cutting rates again is that it further inflates the residential property market.

"However, strong property price gains are largely concentrated in Sydney and the RBA sees this as more of an issue for the prudential regulator, APRA," he said.

"Overall, we see the RBA’s cut as justified and, given that there is rarely just one move, we expect another 0.25 per cent cut taking the cash rate to 2 per cent in the months ahead."

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