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Australia Q2 CPI: An August rate cut on the cards

The Reserve Bank of Australia (RBA) wanted new information on the economy after leaving rates on hold in July.

RBA
Source: Bloomberg

Today’s Q2 inflation numbers may give them more questions than explicit answers and on the whole the woeful headline inflation growth of 1% (year-on-year) is something we are more akin to seeing in Europe or Japan. If the RBA focused specifically on headline inflation then a cut would be in the bag and we could even be debating an even deeper cut. However, that is not the case and the 0.5% quarterly growth in underlying inflation, leading to a 1.7% annualised pace, does throw some concern as to whether they will cut rates in August.

The market is actually left with more questions and a modest amount of increased doubt, with traders desperately wanting certainty. The fact that interest rate pricing has lowered their probability of a cut from 63% to 53% highlights this point, while further out the market has priced out four basis points of cuts over the coming 12 months. Interest rate markets are still discounting one full hike and a 52% chance of a second. Interestingly, we saw an initial spike in the AUD/USD, rallying from $0.7511 to $0.7567, coinciding with a small two basis point move higher in the Australia two-year bond. However, this move hasn’t lasted long, and traders seem to be saying that on balance a cut is the higher probability outcome, with the AUD/USD now testing pre-CPI levels. I would echo this approach and feel the prospect of a cut is still being modestly underpriced by the interest rate markets. Any economist who had an August cut as their base case won’t likely change this call given the steady decline we are seeing in non-tradeables.

The August RBA meeting promises to be a fairly volatile ride for rates and AUD traders.

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