To The Moon

Michele Bullock, Governor of RBA

In a move widely anticipated by markets, the Reserve Bank of Australia (RBA) today announced a cut to the cash rate, reducing it by 25 basis points to 4.10%. This marks the first rate cut since November 2020, signalling a potential turning point in Australia's battle against inflation and the beginning of a new cycle for the Australian economy. While the cut is undoubtedly "very welcome news," as Treasurer Jim Chalmers noted, it's crucial to delve deeper into the reasons, implications, and prospects this decision unveils.  

Australia, like many global economies, has been grappling with elevated inflation. However, the RBA's statement accompanying the rate cut highlights a crucial shift: "underlying inflation is moderating." Indeed, inflation has fallen substantially from its 2022 peak, with the December quarter showing underlying inflation at 3.2%. This figure, while still slightly outside the RBA's 2-3% target band, suggests that inflationary pressures are easing faster than anticipated. This progress, coupled with "continued subdued growth in private demand and wage pressures," gave the RBA the confidence to ease monetary policy.  

Why Cut Now? The Rationale and Justifications

The decision to cut rates today wasn’t taken lightly. After holding steady at 4.35% since November 2023, the RBA faced mounting pressure from multiple fronts. First, economic growth has been anemic—GDP growth in the September 2024 quarter was a mere 0.8% annualized, the slowest in decades outside the pandemic. Household consumption, battered by high borrowing costs and cost-of-living pressures, has stagnated, while the labour market, though resilient at 4% unemployment, shows signs of softening. The RBA likely saw a window to ease monetary policy without reigniting inflation, especially given the “faster-than-expected” disinflation noted in recent commentary.

External factors also played a role. The Australian dollar’s weakness—hovering near 62 US cents after a 9% drop in 2024—has raised import costs, but not enough to derail the inflation slowdown. Meanwhile, global uncertainties, including Donald Trump’s looming U.S. tariff policies, threaten commodity exports like iron ore and aluminium, which could further dampen growth. The RBA’s dovish pivot signaled in its December 2024 meeting, reflects a pragmatic acknowledgment: the risks of doing too little now outweigh the risks of easing too soon.

Immediate Impacts: Australian Dollar, Commodities, and the ASX

The immediate market reaction is predictable. The Australian dollar, already under pressure from a strengthening U.S. dollar, dipped further, falling from 62.3 US cents to around 62.0 cents post-announcement. A weaker AUD is a double-edged sword: it boosts export competitiveness but inflates the cost of imports, potentially offsetting some inflation relief. For households reeling from high fuel and grocery prices, this could temper the cut’s benefits.

AUD/USD

Commodities, a cornerstone of Australia’s economy, face mixed prospects. Iron ore and coal prices, sensitive to China’s economic health, may soften if Trump’s tariffs escalate trade tensions, reducing demand from Australia’s largest trading partner. However, a weaker AUD could cushion the blow by making Australian exports cheaper on global markets. The RBA’s move might also spur domestic demand for commodities like construction materials, though this hinges on a housing sector revival—unlikely in the short term given still-high borrowing costs.

On the ASX, the ASX200 index ( $S&P/ASX 200(XJO.AU)$ ) initially rose post-announcement but subsequently declined by 0.66% to 8,481 points. This downturn was influenced by cautious commentary from the RBA Governor, emphasizing the need for more evidence of sustained inflation reduction before considering further cuts. Lower borrowing costs can boost corporate earnings and investor sentiment, potentially leading to gains in the stock market. Indeed, major banks like Commonwealth Bank ( $COMMONWEALTH BANK OF AUSTRALIA(CBA.AU)$ ), NAB ( $NATIONAL AUSTRALIA BANK LTD(NAB.AU)$ ), ANZ ( $ANZ GROUP HOLDINGS LTD(ANZ.AU)$ ), and Westpac have already announced they will pass on the full rate cut to variable home loan customers, a move that should further stimulate the housing market and consumer spending. However, the RBA also flagged concerns about "continuing subdued output growth" and a "sharper deterioration in the labour market," suggesting that the economic outlook is far from uniformly positive.

S&P/ASX 200

Future Outlook

Looking ahead, predicting the RBA's next moves remains challenging. The central forecast for underlying inflation has been "revised up a little over 2026," indicating that the path to sustained price stability is still uncertain. While markets are pricing in further rate cuts this year, the RBA's cautious stance suggests that future decisions will be heavily reliant on incoming economic data, particularly on household spending, labour market strength, and productivity growth. As the RBA itself admits, there are "uncertainties regarding the lags in the effect of monetary policy" and how businesses and wages will respond to the current economic conditions.  

In conclusion, today's RBA rate cut is a significant development, signalling progress in the fight against inflation and providing welcome relief to borrowers. However, it is not a signal of unbridled optimism. The RBA is

navigating a complex economic landscape with "risks on both sides." While the rate cut may provide a much-needed boost to the Australian economy, the path forward remains uncertain, and further policy adjustments will be data-dependent and carefully considered. The RBA has taken a cautious step towards easing, but the inflation battle is far from over, and vigilance remains the watchword.

@TigerWire