The outlook for Australian Interest rates: The RBA set for a highly active 2H25

The RBA will consider how this monthly inflation rate plays into the more important Q2 CPI release (due on 30 July). However, given the July RBA meeting takes place on 8 July, and sometime before the RBA receives the Q2 CPI data, the RBA must decide if the May CPI data provides them the sufficient confidence to lower the cash rate by 25bp to 3.6% at the upcoming meeting.

Reconciling the Aussie May CPI data to the SoMP forecasts

In the May Statement on Monetary Policy, the RBA forecasted headline CPI for the June quarter to come in at 2.1% and trimmed mean CPI at 2.6% - so, while the RBA put less weight on the monthly inflation figures, today’s data would sit well with the bank and would almost certainly give them the scope to ease again in the July meeting.

Market pricing for RBA policy

In response to the CPI data, the Aussie interest rate swaps market has moved to price 24bp of implied rate cuts for the July meeting - essentially ascribing a 97% probability for the RBA to lower the cash rate.

With no major economic data set to impact ahead of the July meeting, a 25bp cut is seen as a done deal in the market’s eyes and with no scheduled speeches from RBA officials leading into the meeting, unless we see the RBA choose to guide market expectations lower – perhaps through an opinion piece in the AFR or WSJ – one can assume a cut is firmly on the cards.

Further out the rates curve, we see 82bp of implied cuts priced by December – this assumes a base case for a 25bp cut in July, August, and November. In fact, the market is toying with the idea that the RBA could even cut four times this year, possibly squeezing another cut in at either the September or December RBA meetings.

How low can the RBA cash rate go?

What is interesting is that the ‘terminal’ pricing, or the implied trough point for where the RBA could take the cash rate is currently implied at 2.90% - this implies four 25bp rate cuts in the entirety of the easing cycle. This assumed low point of 2.9% is also 30bp (or 0.3%) below the RBA’s own estimate for where the neutral rate is currently estimated to be (at 3.2%). The ‘neutral rate’ being the perceived rate setting which is neither stimulatory nor restrictive and falls in perfect equilibrium with the inflation and growth dynamic.

While the interest rates markets have a history of overshooting the eventual reality, one questions if this implied forward policy setting – one that is somewhat stimulatory – suggests the market is sensing an increased risk of recession 12 months out.

I would argue that to be the case and while this implied pricing does not suggest a collapse in economic activity, if this implied low point in swaps pricing is taken to say 2.5%, I would argue this would be a powerful signal that all is not well in the domestic economy, with the market making a statement that the RBA need to go harder on stimulating demand through the rates channel.

The connection to Aussie markets

• What does this mean for the ASX200 banks, who will see their net interest margins (NIM) negatively impacted by the lower lending rates? A reduced lending rate would naturally lower NIM, although, in recent weeks the banks have been cutting term deposits more aggressively - so this will offset the effects from a lower cost of borrowing for households and businesses, and force savers further out of the risk curve.
• What does this mean for REITS, consumer plays and other interest-rate-sensitive stocks?
• What does this mean for house prices, which have already responded positively in recent months?
• What does this mean for the high dividend, high yield equity plays?
• What does the more aggressive rates pricing mean for the AUD? Are the cuts now sufficiently discounted that when they are realised it won’t move the dial on the AUD? Or will this dynamic see the AUD underperform, especially vs the AUD cross rates: AUDNZD, EURAUD, GBPAUD etc…

Bring on the July RBA meeting

We look to the July RBA meeting – a cut at this stage is seen as a done deal - but having already cut the cash rate twice, the market is currently implying the RBA front load further cuts, as opposed to taking a more measured stance. We know the RBA were slower than other central banks to start the easing cycle, but the more aggressive the perceived pace of cuts, the greater the prospect of higher volatility in the market sensitive to a lower cash rate.

Good luck to all.