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Central banks are gearing up for rate cuts in the North Atlantic, but the RBA still has a tightening bias. Our latest forecasts for interest rates, financial markets and the domestic economy ahead of the March RBA policy meeting.
The latest GDP data showed as forecast 0.2% growth for the last quarter of 2023, meaning the Australian economy grew by 1 ½ % last year, but we remained in a per capita recession as the population grew by more than 2 ½ %. There were few bright spots in the data, although government spending and private investment preventing the economy from contracting, while household spending remained weak and dwelling investment is yet to pick up.
As the chart shows, net trade did support economic growth, matching recent evidence that while domestic demand is low, service exports are still strong, and while households remain under pressure with more falls seen in discretionary spending, at least the household savings ratio recovered a little, and disposable income did rebound in Q4.
As for the consequences of this for the Reserve Bank, it’s most unlikely to convince the RBA board to remove its tightening bias in the March meeting, with house prices continuing to rise, fiscal stimulus on its way and ‘unit labour costs’ still up 6.6% year-on-year.
Ultimately, RBA rate cuts will depend on core inflation returning to or below 3%, and while the latest Monthly Indicator showed CPI down to 3.4%, the core measure was still up at 3.8% in January, which is exactly where we have forecast it will land in the next quarterly numbers out in late April.
The RBA’s preferred measure of core inflation, the Trimmed Mean, was 4.2% at the end of 2023 and should continue to ease, but while a fall to 3.8% may see the RBA remove its tightening bias in the May meeting, it won’t be enough for rate cuts until September at the earliest.
A sharper increase in the unemployment rate could justify this timing if labour markets were to weaken markedly, but it will be difficult for the RBA to provide monetary policy support at the same time as tax cuts and soon after the fiscal stimulus expected in the May budget, so a spring RBA cut risks only being able to deliver one or two rate reductions, while our preferred scenario of waiting for 2025 should enable 5 cuts down to 3.1%.
Elsewhere progress on inflation has been promising with the US Core PCE down to 2.8% year-on-year, suggesting the US Federal Reserve will be cutting rates by June, and similarly, for the European Central Bank.
So, as other advanced economy central banks declare the war on inflation has been won, and start to ease policy mid-year, there will be increasing calls for the RBA to do the same. However, it’s important to keep in mind that we were around 6 months behind in the initial tightening cycle and didn’t hike as aggressively.
And lastly, asset prices remain at record highs for stocks and property, with markets continuing to bank the expected rate cuts and the hope of a soft landing in the US. The US yield curve remains inverted, so this is a big assumption.
But for the Australian dollar, while the strong US Dollar is likely to keep the Aussie around 65 to 67 cents for some months, we do expect some relative strength emerging in the second half as the Fed eases rates while the RBA sits pat, potentially seeing a move above 70 cents.
And that’s the market update from Bendigo Bank.
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