RBA claims uncertainty; easing financial conditions are the real reason

The RBA clearly wrong-footed financial markets and economists yesterday by electing to keep interest rates unchanged. Only five of the 32 people surveyed by Bloomberg expected the RBA to remain on hold, and financial markets yesterday were 100% priced for a 25 bps reduction.

This is one of the strangest decisions that the RBA has made in the inflation targeting era. As a reminder, the Australian economy expanded just 1.3% (y/y), remains mired in a per capita recession, and the latest inflation data suggests headline inflation of just 2.1% (y/y) over the year to May and trimmed mean inflation of 2.7% (y/y) – well within the target band of 2-3%. Moreover, there are few signs that the prior 50 bps of easing has created anything other than a tepid response (see Chart 1).

Chart 1: Australia’s activity and inflation data continue to undershoot modest expectations

The RBA decided to make itself the story today. In recent years the RBA decided that a measure of its own success is how well it had communicated its intention to the financial markets, firms and households so as to avoid shocks in expectations. Yet despite overwhelming expectations for an easing and economic data that had continued to undershoot modest expectations, the RBA did not roll back market expectations in any meaningful way in the days leading into the decision.

One can only assume that the RBA chose to remain on hold due to an easing in financial conditions, principally due to the strong rebound in equities and narrowing credit spreads (see Chart 2), and fears that back-to-back rate hikes may ignite the housing market. Of course, the RBA has rolled out the excuse of wanting to wait for further information amid high levels of global uncertainty, however, if anything there is currently greater certainty on geopolitical events than at any time since early April.

Chart 2: Financial conditions have eased sharply in the US relative to Australia

It is of note that the vote was far from unanimous. Six of nine voted for the decision, suggesting that three members of the Board likely voted to ease rates yesterday.

If this is merely a tactical pause in an effort to induce a slower cadence of easing to contain asset price growth but ultimately no change in the final destination for rates then today’s pause is small beer, as the easing cycle remains on track albeit just a bit more elongated. However, if this is a sign that the RBA is so unsure of its path that it cannot agree on the strategy to return real interest rate settings towards ‘neutral’ then Australia’s private sector will remain locked in its growth paralysis for longer.

From our perspective the RBA gains little by pausing for a month and has clearly failed in communicating with stakeholders its intentions ahead of time. The Governor suggests that post the RBA reforms it can no longer pre-empt the Board’s decision and seek to guide expectations in the intermeeting period. This is of course a retrograde step, which was one of the criticisms we levelled at the suggested reforms, but it is also nonsense to suggest that in a situation where the market is treating a prospective RBA decision as a certainty and the RBA Board members preference is to pause, that the RBA cannot convey that uncertainty in a timely manner. While the RBA may prefer to say it has retained optionality, yesterday’s decision looks more like an own goal. The RBA has merely allowed real interest rates to drift higher at a time of faltering economic growth and contained inflation risks.

We expect the RBA will ease in August and November in 2025, and we have added a further cut in November 2026, retaining our 2.6% terminal cash rate forecast for this cycle.

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