The Reserve Bank of Australia (RBA) has delivered its first interest rate cut of 0.25% since it began its tightening cycle in 2022. Relative to most of its global peers in other developed markets, RBA is probably the last central bank to begin its easing cycle. However, the interest cut was accompanied with comments from the RBA Governor Michele Bullock that the market shouldn’t assume more rate cuts in 2025. That the current rate cut expectations of three in 2025 may be too many.
Coming in for a soft landing
It appears the RBA has manufactured a “soft landing” for the Australian economy through a myriad of risks – RBA cash rate increasing from 0.1% to 4.35% over a 18-month period, significant amount of Australian mortgagees shifting from fixed rate mortgage to variable rates, a massive spike in inflation & bringing inflation back towards the bank’s target rate, not causing a major spike in the unemployment rate, geopolitical tensions from abroad and avoiding a recession. While it appears, we have avoided an economic calamity, the Australian economy hasn’t come away completely unscathed. The economic growth is sluggish, productivity growth is non-existent and real economic growth rate over the next two years is forecast to be a touch below 2.0%.
Did the RBA need to cut?
According to Governor Bullock comments following the rate cut decision, it was a close call whether to cut or remain on hold. The RBA could have easily remained on hold.
Firstly, while the headline inflation rate of 2.4% now sits within RBA’s target range of 2-3%, the core inflation reading of 3.2% remains above the target range. Secondly, while we are cognizant the share market is not necessarily a reflection of the real economy, nonetheless the S&P/ASX 200 is trading on a forward price-to-earnings multiple of 18.5x and dividend yield of 3.3% – both well above their respective long-term average. These valuation metrics don’t suggest to us that “animal spirits” are missing. Evidently, the consumer and economy are sluggish but muddling through. If the RBA miss-times the rate cutting cycle, it potentially invites back speculative behaviour (including the property market) and the threat of inflation reaccelerating.
However, there is one economic indicator that does support the RBA’s rate cut – that is Australian wage growth. Wage growth in Australia is starting to moderate from its peak which does support the case for lower inflation ahead and therefore gives the RBA room to begin the easing cycle.
U.S. growth concern
In terms of global growth, Japan and the U.S. delivered strong growth in the fourth quarter of CY24. While Europe continues to struggle, with Germany standing out as a major concern. In recent days, economic data out of the U.S. was also on the soft side. Recent movements in the markets – such as bond yields rallying, defensive sectors healthcare & consumer staples outperforming technology – could suggest investors are moving from inflation concern to growth concern.
