There’s something called a “momentum trade” on financial markets.
The biggest momentum on financial markets right now must surely be bets on the Reserve Bank cutting interest rates in February.
At the start of December, the market priced the odds of a February rate cut at about 25 per cent.
Some commentary following the RBA’s December meeting lifted those odds above 50 per cent.
Since then, they’ve generally hovered between about 60-75 per cent, despite some surprisingly strong December jobs numbers that threw a February move into question.
But Wednesday’s inflation figures, coming in lower than either the Reserve Bank or most market economists predicted, have seen those odds skyrocket to 95 per cent.
If this was a horse race, a rate cut on February 18 is now looking like a punt on Black Caviar (who went 25 races undefeated).
‘It’s on for February’
It’s not just traders scrambling over themselves to bet on a rate cut next month.
Even as markets priced in a better-than-even chance of rates falling in February, the majority of local economists believed the RBA would hold out until May.
That has flipped on Wednesday, with one economist after another sending out notes shifting their rate cut forecasts forward.
Two of the big four banks had already tipped a February rate cut ahead of Wednesday’s numbers, but Westpac has now joined them and NAB is reviewing its position.
The views of Westpac’s chief economist Luci Ellis carry some extra weight. She was the RBA’s assistant governor in charge of economics until about a year-and-a-half ago.
That means she was literally in the room for the bank’s rate decisions. Few people outside the walls of the Reserve Bank would have a better idea about its current thought processes.
Her note is titled, “it’s on for February”.
“The CPI has been the deciding factor because the message from other available data has been so mixed,” she observes.
“With trimmed mean inflation at 0.5 per cent in the quarter (3.2 per cent for the year), we have just enough evidence to conclude that disinflation has proceeded faster than the RBA expected, so the Board will have the required confidence to start the rate-cutting phase in February.”
Will the RBA sit still at a green light?
She doesn’t present this as a fait accompli, noting that the RBA will have to make a further leap in its economic forecasts to justify a rate cut, given its previous comments.
“We therefore cannot completely rule out that the Board (and the staff) dig in on their assessment that the demand is still outstripping supply, and keep rates on hold,” she cautions.
“The run of inflation data of late makes such an assessment even harder to justify, though.”
And that’s the biggest shift in momentum from the latest inflation data.
Before these figures, the RBA would’ve been under considerable pressure to justify a rate cut if it decided to move next month.
That’s now completely flipped. As CBA’s head of Australian economics, Gareth Aird, put it, “today’s data has given the green light for the RBA to commence normalising the cash rate”.
If the RBA chooses not to take its foot off the brake by keeping rates steady at 4.35 per cent on February 18, governor Michele Bullock would be under immense pressure to justify why.
That pressure will now come from almost all quarters — mortgage borrowers, journalists, the federal government, financial markets and economists.
Easier to swim with the tide
Luci Ellis is adamant that “the RBA Board has historically set policy according to the demands of its mandate and its assessment of the economy without political considerations”.
Of course, the RBA started raising rates less than three weeks out from the 2022 election that saw Scott Morrison’s Coalition government dumped.
And whatever it does this time will again be seen through a political lens — if it cuts in February or April, before a federal election, that will be seen as a boost to Labor, while delaying a rate cut until after the election in May would be viewed as a fillip to the Coalition’s chances.
However, even she admits that “the forthcoming change of the make-up of the Board could create some awkward optics around timing”.
The Albanese government’s move, recommended by the RBA review, to split the current board in two — with one focused on monetary policy while the other runs the bank’s many administrative and business functions — happens in March.
That means the make-up of the current monetary policy board will change between the February meeting and the April 1 meeting, when the treasurer’s new appointments take their place at the interest rate decision-making table.
“If the current Board held rates steady in February and then the revamped Board cut rates in April, it would look like the government ‘stacked’ the Board to get the desired result,” Ellis notes.
“So there is an argument that the current Board will opt to get on with it rather than get caught up in the politics of the situation.”
Tricky politics aside, when the tide turns, it’s a lot easier to swim with it than against it.