One major bank's chief economist is confident the RBA will lower the official cash rate later today after he correctly forecast a rate cut last month.
On December 4 last year, Westpac's Bill Evans forecast that the Reserve Bank would decide to cut the cash rate by 25 basis points at both its February and March meetings.
“At that time market pricing put the probability of consecutive rate cuts at around 15 per cent with the probability of the February rate cut alone (that has since been delivered) at only around 20 per cent,” Mr Evans said.
Arguments that the RBA would wait to assess the impact of the February cut overlook central banks’ assessments that monetary policy acts with a long and variable lag, he said.
“It is more likely that the Reserve Bank has assessed the situation has changed sufficiently that at least 50bps of cuts are going to be required,” he said.
Mr Evans is confident that the need to trade off the risks of over-stimulating the Sydney property market with the need to contain the rise in unemployment is likely to have been resolved in favour of the labour market.
Under those circumstances, waiting for a month or two would seem to be a sub-optimal strategy, he said.
Westpac’s chief economist noted that the Reserve Bank justified last month’s rate cut on the basis that consumption and non–mining investment were taking longer to recover than had previously been expected.
However, developments since the February rate cut have strengthened the case for a cut today.
“On February 12 the employment report printed an increase in the unemployment rate from 6.1 per cent to 6.4 per cent,” Mr Evans noted. “While that sharp jump should correctly be interpreted as partly monthly volatility, it would have confirmed to the RBA that the unemployment rate had not peaked,” he said.
The Australian dollar is also being closely monitored by the Reserve Bank as it prepares to set monetary policy.
In December last year, RBA governor Glenn Stevens said he saw the Aussie dollar needing to fall to US$0.75.
Westpac’s estimate of fair value puts it at around that level, Mr Evans said.
“Prior to the rate cut in February the AUD was trading around US$0.78. Immediately following the cut, the AUD traded down to US$0.765 although that level proved to be unsustainable in the near term,” he said.
“That was probably because the governor gave no guidance in his statement, leaving the market with the perception of a neutral bias.
“Since then the AUD recently traded around US$0.79 and is currently around US$0.785. Markets are currently pricing a rate cut next week with a probability of 50 per cent so no move will probably further boost the AUD.”
Mr Evans said the key to today’s decision will be whether the governor sees the cash rate as having a natural 'floor' of 2 per cent.
“In that case, cutting rates with an associated neutral bias might see markets assessing that the RBA has exhausted its rate cutting capacity,” he said.
Such an assessment would be dangerous from the perspective of holding down the Aussie dollar, he added.