Sweet relief but the symptoms remain

33 months after her predecessor began raising rates post-pandemic, Michele Bullock has finally cut rates. The 25 bps cut  was widely expected but the market is not sure how to feel about the hawkish tone of the decision. While the cut brings sweet relief to mortgage holders, it may be a one-off treat in a continuing diet of restrictive monetary policy.

What the RBA’s Statement said

“In removing a little of the policy restrictiveness in its decision today, the Board acknowledges that progress has been made but is cautious about the outlook.”

“However, upside risks remain. Some recent labour market data have been unexpectedly strong, suggesting that the labour market may be somewhat tighter than previously thought.”

“The forecasts published today suggest that, if monetary policy is eased too much too soon, disinflation could stall, and inflation would settle above the midpoint of the target range.”

“...there is a risk that any pick-up in consumption is slower than expected, resulting in continued subdued output growth and a sharper deterioration in the labour market than currently projected. Alternatively, labour market outcomes may prove stronger than expected, given the signal from a range of leading indicators.”

Statement by the Reserve Bank Board: Monetary Policy Decision, 18 February 2025.

https://www.rba.gov.au/media-releases/2025/mr-25-03.html

What the governor said at the press conference

“The Board judges its time to reduce a little of the restrictiveness but we cannot declare victory over inflation just yet.”

“The strength of the labour market has been surprising. Many indicators suggest that the labour market is tight and on some measures it is tightening further. While this is good news for job seekers the Board remains alert to the possibility that it is signalling a bit more strength in the economy which could delay or stall the disinflation process.”

“Today’s decision does not imply that further rate cuts along the lines suggested by the market are coming”

“We are still restrictive and are waiting for more evidence that we are getting inflation sustainably back in the band before we are willing to move again.”

“In the past we thought demand was a bit above supply but now we are a  bit uncertain if that is still the case so it would be really good to see some recovery on the supply side of the economy and obviously productivity is an important part of that as well.”

Easing restrictiveness … a little

After signalling in December that it was now leaning towards a cut, the RBA cut interest rates by 25 bps in February.

With headline and trimmed-mean inflation falling in the December quarter, the cut was widely expected. Government subsidies have (temporarily) lessened electricity costs while existing house prices have eased, and rental costs are finally decreasing with more room to fall (see chart below).

However, Bullock was at pains to point out that the cash rate clearly remains at a restrictive setting: being above any estimated neutral rate (see chart below). Further, she stressed that it was not time to declare victory against inflation yet and that the market was getting ahead of itself by forecasting several more rate cuts for 2025. The cut was just a little bit of easing to recognise that progress is being made. Mortgage payers and the Labor government said “thanks and more please”.v

The unexpectedly tight labour market

While the Board’s decision was unanimous according to Bullock (going forward we will be told the exact vote), she siad there was a lot of back-and-forth discussion centering around the labour market.

Bullock admitted that the labour market is still tighter than expected, as evidenced by the low rate of unemployment, and by some measures it is getting tighter still (vacancies to unemployment ratio and constraint measures are rising again - see charts  below).

However, while perplexed, the RBA is breathing sighs of relief because the tightness is not currently pushing up wages. If that were to change, the RBA would re-embrace its inner hawk.

Once again, Bullock also mentioned Australia’s current low productivity. While it looks like productivity has finally recovered from the pandemic, the RBA would love to see some nice increases going forward as has happened in the US recently . However, the RBA has revised down productivity in its latest forecast (see chart below). Productivity is now not expected to grow until the second-half of 2025.

Improving productivity is important because it would give wages some more buffer  room to move up and would help bring supply higher and closer to demand, thereby closing the inflationary output gap. However, Bullock did confess that the output gap is now smaller than previously thought and may have been eliminated! Stay tuned!  

Tariffs and global uncertainties

Of course, reflecting this brave new world of Trumponomics, Bullock was asked whether the Board had factored in the potential impact of US tariffs. Bullock rightly replied that their level and impact remains to be seen but that the RBA would first consider the impact on global economic growth and particularly China’s growth given the importance of China to Australian export sectors. The inflationary impact would be a more distant secondary consideration.

However, as anyone watching US stock markets can attest, the RBA’s Statement of Monetary Policy for February argued that there has been no big jump in equity risk premium, which suggests that markets do not believe that Trump's tariffs will be implemented on a widespread basis or will not have a huge trade impact. 

Australian Private Debt Market

While the RBA shifted its gears down, monetary policy and the Australian economy remain business as usual!

What the RBA does next will depend on what happens in the labour market and whether the Australian economy shakes off its sluggish September GDP result and avoids any downsides from  global economic uncertainties