Markets: Retail drives a rate cut?

The trading floor is abuzz with growing expectations of a reduction to the official cash rate after yesterday's retail numbers.

The chances of a rate cut are going up.

The stock market may believe it. At 1345 AEST the S&P/ASX200 Index had gained 43.0752, or 0.9 per cent, to 4787.20 as chatter of a potential cut on trading floors and among analysts grew after yesterday’s retail sales came in below forecasts pointing to a very subdued economic climate.

Reserve Bank of Australia deputy governor Philip Lowe said today in Sydney that the Reserve’s monetary policy committee yesterday “did deliberate for a very long time,” before deciding not to change the benchmark cash rate, currently at a record low of 2.75 per cent. But Lowe, said, monetary policy meetings are usually long. They normally last from 0900 to 1245 AEST. Yesterday was no different.

But some analysts, both those who think a cut is now more likely and those who forecast no change in monetary policy at next month’s monetary policy committee meeting, say yesterday’s retail sales may have given the central bank pause. May retail sales rose 0.1 per cent, below forecasts of 0.3 per cent. April and March retail sales figures were downgraded by $110 million. Retail sales have fallen five out of the last eight months.

“There is no reason not to cut,” says Matt Sherwood, the strategist at fund manager Perpetual who worked at the Reserve Bank of Australia. “The economy is very weak at the moment”.

Joshua Williamson, a Citigroup economist, agrees the local economy is perhaps weaker than expected. But he expects inflation figures for the three months to June not to be weak enough to encourage the central bank to cut again. Williamson forecasts Australia’s second-quarter inflation figure to be 0.5 per cent. He thinks the rate would have to be 0.4 per cent, or an annual inflation rate of 1.6 per cent, before the Reserve will cut the cash rate again.

Economic growth this year is expected to be 2.5 per cent. That, Williamson says, “will keep the RBA happy”. Previous rate cuts have yet to work through the economy. The more-than 12 per cent decline in the Australian dollar since April is doing some of the Reserve's work by making Australian business more competitive.

Sherwood says the central bank wants the Australian dollar to fall even lower from current levels, to 74 US cents. Wage pressures, that could fuel inflation, are declining. Inflation is at the bottom of its target of 2 per cent to 3 per cent per annum, says Sherwood. “This will clear the way for further rate cuts,” he says.

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