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When financial markets begin to price in rate cuts, the RBA usually delivers, eventually

David Scutt
  • Since 2005, whenever financial markets have priced in RBA rate cuts, the bank has usually delivered -- eventually.
  • As things currently stand, a 25 basis point rate cut is still fully priced by the middle of next year.
  • ANZ Bank says the "hurdle for a rate cut remains fairly high" and would require a "sustained deterioration in the labour market and step-down in consumption growth".
  • ANZ sees the RBA cash rate remaining unchanged at 1.5% until the second half of next year. The cash rate has been at its current level since August 2016.

When financial markets begin to price in rate cuts from the Reserve Bank of Australia (RBA), the bank almost always cuts rates -- eventually.

This chart from ANZ Bank shows the differential in market pricing for the cash rate looking around 18 months ahead compared to the actual level of the cash rate since 2006.

More often than not over this period, when the market moves to price in additional easing, the RBA almost always will oblige.

"Since 2005, in almost all instance in which markets have started pricing cuts aggressively, the RBA has eventually cut," says ANZ's Australian economics team, led by David Plank.

"However, the lag between the market first pricing a cut and it happening has been quite variable.

"In the most recent instance, when the RBA cute from 2% to 1.75% in 2016, there was a lag of 300 days."

So the RBA usually moves the cash rate lower when markets have already began to price in the likelihood of further easing, although the reaction function from the bank is not always immediate.

While financial markets pared back collective expectations for additional easing late last week, a full 25 basis point cut is still priced for delivery by the middle of next year.

Despite the recent track record, ANZ says those in markets anticipating a 25 basis point cut during this period may end up being disappointed.

"The front-end rallied sharply following the RBA’s move towards a neutral policy outlook," ANZ says, referring to market move following the RBA's admission that the next move in the cash rate now appears to be "evenly balanced".

"Our view is that these moves are an overly dovish interpretation of the RBA, although not to an extreme extent.

"The hurdle for a rate cut remains fairly high and would require a sustained deterioration in the labour market and step-down in consumption growth.

"We struggle to see this happening by the time of the RBA’s May forecast update."

Currently, ANZ expects the cash rate will remain steady at 1.5% until the middle of next year, in line with the vast majority of economic forecasters polled by Bloomberg.

Of those expecting a move over this period, most are anticipating, like markets, that the next move will be lower.

Australia will receive a double-dose of important labour market indicators this week, starting with the December quarter Wage Price Index. That will be followed on Thursday by labour force data for January.

Both releases carry the potential to shift market expectations for the cash rate in the months ahead.