RBA: No further easing in 2016 - HSBC

Research Team at HSBC, notes that the Reserve Bank of Australia cut rates to a record low of 1.5% on 2 August and the RBA’s rate cut is an attempt to pull inflation back to its 2-3% target.

Key Quotes

“As far as the currency is concerned, July’s RBA minutes highlighted the belief that “an appreciating exchange rate could complicate the necessary economic adjustments”. In other words the AUD is an important variable in the RBA’s inflation fighting criteria. On the rate announcement AUD-USD initially dropped 0.7%, yet this move reversed quickly and the AUD ended up for the day. This outcome must have been disappointing for the RBA. Perhaps the reason for such price action is the rate cut was fully priced in and the market was hoping for more. For this meeting twenty out of twenty five economists surveyed on Bloomberg were expecting the rate cut.

The reaction function of the AUD shows that when a central bank cuts rates as expected and does not over deliver, the currency appreciates. This was also shown in the case of the RBNZ, where a 25bp cut as expected saw the NZD strengthen. We have seen similar market reactions recently when other central banks have either under or over delivered. In the case of the Bank of Japan, its monetary base target and policy rate were left unchanged on 29 July. Just under half of economists surveyed expected an expansion of the monetary base target, and exactly half of economists expected a rate cut. The BoJ’s failure to over deliver created substantive JPY strength. In the case of the Bank of England, MPC members delivered by cutting rates and delivering further QE, causing GBP to fall. Delivering more than expected can produce a sizeable market reaction.

An appreciating AUD is unwelcome news for the RBA. Given the RBA will not deliver QE and intervention is a far off proposition, what strategy could they use to prompt AUD weakness? The answer takes us back to the RBA meeting on 3 May when they surprised the market with a 25bp rate cut. This saw AUD fall from 0.76 to around 0.71 by month end. At the time of writing only 26% of economists surveyed on Bloomberg are expecting an additional rate cut this year. HSBC does not expect further easing in 2016. The question is: how could the RBA counter an unwanted appreciation of the currency that would further undermine their inflation target? Doing the unexpected seems to have a pronounced impact on the currency. This makes us wary of them perhaps doing the unexpected again.”