RBA to Cut Interest Rates for Third Consecutive Time in February

We expect the RBA will reduce its cash rate by -25 bps to 4.0% at the February meeting. This third consecutive rate cut since November would bring the country's monetary policy to mildly accommodative from neutral. Given high uncertainty in global economic outlook and weaker tone in recent domestic developments (rising unemployment, benign inflation and appreciation in AUD), we believe a rate cut is justified. The RBA will release its quarterly Statement on Monetary Policy and policymakers should use this opportunity to communicate more about its rationale of the new policy settings.

At the December meeting, the RBA cited moderation in global economy, the dire situation in the Eurozone and softened domestic economic situation as reasons for the rate cut. These factors appeared to have deteriorated further since that meeting. Although data in released in the US sent some pleasant signals, its outlook is not yet out of wood and the Fed signaled further easing at the January FOMC meeting. The EU summit made little progress on resolving the sovereign debt crisis in the Eurozone. Further downgrades were made on credit ratings of a number of Eurozone countries.

Domestically, Australia's job market softened in the second half of the year. While the jobless rate remained at 5.2% in December, it was due to a drop in the participation rate, rather than a rise in the number of payrolls. Headline CPI was flat over 4Q11, following a +0.6% gain in the prior quarter. Moderation in inflation was driven by the decline in fruit and vegetable prices. Core CPI climbed +0.6% q/q, from an upwardly revised 0.4% in 3Q11, bringing inflation up +2.6% over the year.

The Australian dollar has risen more than +5% against the US dollar since the last meeting. This suggests that despite the previous 2 rate cuts, financial market conditions have remained tight. According to the RBA Bulletin, the last rate cuts have only lowered interest rates charged on business loans by an averaged 15 bps. The central bank would find it necessary to lower interest rates more to relieve financial conditions.