RBA opens the door to a rate cut – but what will we need to see before it happens?

The Reserve Bank of Australia has swung open the door to a rate cut according to economists, stating it may need to adjust rates if global economic conditions continue to deteriorate and domestic demand weakens.

But a few hurdles need to be jumped before the sweet relief of an official rate cut comes to pass.

RBA governor Glenn Stevens has previously indicated that the central bank was more worried about rising inflation in Australia than the global outlook for growth but the bank now appears to be  concerned about the short-term outlook for the global economy. 

“While there remain good reasons to expect solid growth over the medium term, the indications are that the pace of near-term growth is unlikely to be as strong as earlier expected, due both to local and global factors, including the financial turmoil and related effects on business confidence,” Stevens says.

Indeed, the inflation concerns appears to be retreating, with Stevens saying recent data suggested “a pick-up to date in the underlying pace of price rises that was less sharp than initially indicated.

“Moreover, with labour market conditions now a little softer and households more concerned about the possibility of unemployment rising, the likelihood of a significant acceleration in labour costs outside the resources and related sectors is lessening,” he says.

If inflation remains a non-issue and the global economy continues to struggle, Stevens is ready to cut, saying: “An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.”

As Westpac’s chief economist Bill Evans says: “That does not mean that the Bank is committing to a rate cut at its next meeting in November. However it does indicate that the inclination is now towards cutting rates.”

But what will the bank want to see before it implements cuts?

ANZ’s top economists Warren Hogan and Katie Dean wrote in a research note yesterday that there are three basic conditions that need to be fulfilled:

• Confirmation that inflation is under control. This should occur on October 26 with Q3 inflation expected to print modestly (ANZ preliminary forecast is +0.6% for underlying inflation).

• Further evidence that the labour market has softened. Next week’s labour market data remains a wildcard but the recent sustained softening in ANZ job ads at the very least suggests any bounce in employment next week would most likely be an aberration.

• A further deterioration in global conditions, and in particular further corrections in equity markets and commodity prices, and a further widening in corporate credit spreads. Indeed, the credit channel remains the biggest source of risk to the Australian economy from current global events.

Hogan and Dean say the three conditions could be met this month, leaving the door open for a Melbourne Cup Day rate cut on November 1.

But former Paul Bloxham, a former RBA economist and now chief economist at HSBC in Australia, isn’t so sure.

“We still expect the RBA to be on hold for the rest of this year,” Bloxham says.

“While the medium term outlook for rates is more uncertain than usual, as it very much depends on the global outlook, we still think the next move will be up, rather than down, due to inflation risks.”

Either way, yesterday’s rate cut is good news for SMEs. Rates will remain stable or fall in the remainder of 2011, which should help soothe the nerves of consumers.