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News and discussions from Novus Capital

Financial markets are still betting on rate cuts this year

 

Financial markets are betting official interest rates will be cut in three months time, with the likelihood of another reduction later this year, despite the Reserve Bank indicating this week that the case for lower rates had not been made.

After the central bank left official interest rates on hold at a record low of 1.5 per cent on Tuesday, markets have slightly pared back expectations of rate cuts this year. But many remain convinced that the RBA will soon lower borrowing costs.

All eyes will be on the jobs data in the months ahead, especially the unemployment rate, amid debate over which figures best reflect the health of Australia's economy: the weak economic growth figures or the stronger labour market numbers.

On Wednesday, ANZ head of Australian economics, David Plank, said futures markets had "fully priced in" a 0.25 rate cut in August, and there was a "pretty high" chance of a second cut of this size by the end of the year.

"The market went from pricing more than two [interest rate cuts], to a bit less than two, by early next year," said Mr Plank, who also expects rates will fall this year.

National Australia Bank chief economist Alan Oster said a key reason why rates had been left on hold this month, despite very weak inflation and two quarters of soft economic growth, was that the RBA had more faith in the monthly employment data than the numbers on gross domestic product. Latest ABS figures showed an unemployment rate of 5 per cent in March.

When the RBA left rates unchanged on Tuesday, Governor Philip Lowe highlighted the importance of jobs data, saying further "improvement in the labour market" would probably be needed to get inflation — which was just 1.3 per cent in the year to March — back inside its 2 to 3 per cent target range.

Mr Oster, who is forecasting a cut in July, said if the unemployment rate rose for a few months in a row, that would probably be enough to trigger an interest rate cut.

"The unemployment rate is critical. If it starts going north, that's a problem," Mr Oster said.

Mr Oster argued the labour market was weaker than the 5 per cent rate of unemployment would suggest, pointing to the high proportion of people who would like more hours of work.

Among the big four banks, Westpac is also tipping further interest rate cuts this year, while Commonwealth Bank is currently forecasting no change.

Mr Plank said markets would be seeking greater clarity on the RBA's views on the state of the economy in the RBA's Statement on Monetary Policy this Friday, and a speech from Dr Lowe later this month.

Dr Lowe on Tuesday also noted a recent decline in bank funding costs, pointing out that even though some lending rates had declined, average mortgage rates were unchanged.

Mr Plank said that if any reduction in bank funding costs were passed on to variable rate borrowers it would be a "modest easing" from the perspective of the RBA, and was unlikely to meaningfully influence the outlook for employment or inflation.

There is also uncertainty over how long banks may take to lower their variable rates, if at all, and whether their funding costs will remain at current levels.