The Reserve Bank of Australia meets on Tuesday for its latest policy decision, with an announcement expected at 03:30 GMT. Having clearly signalled at its previous meeting that the Bank is planning to stay on hold for the foreseeable future, markets were caught by surprise from recent dovish comments by Deputy Governor Guy Debelle. The Australian dollar tumbled in response as short-dated Australian government bond (AGB) yields slipped. But investors are not fully convinced that further easing is imminent as interest rate futures have not budged much, meaning there is plenty of scope for volatility should the RBA perform a significant shift in its policy stance.
Doubts about Australia’s recovery
Australia may be doing a better job than most countries in quickly containing mass outbreaks of the coronavirus but that has come at an economic cost. The re-imposition of the lockdown in the state of Victoria and tightened restrictions in some of the other states appear to have knocked back the recovery. The services sector likely contracted in August, barely recovering in September according to business surveys, as consumption fell back after people were house bound again.
The setback in Australia’s recovery, as well as increasing doubts about the strength of the turnaround elsewhere in the world, are probably what are causing policymakers to rethink their earlier cautiously upbeat forecasts. The RBA has a tendency of being overoptimistic and it may have once again given too much weight to the upside risks.
Is an October rate cut premature?
But even if the Bank is now less confident about the recovery, is a rate cut or some form of policy easing premature in October? The answer to that is probably yes. Like most other central banks, the RBA has a limited arsenal available at its disposal so it will want to think very carefully about how it uses up its remaining ammunition.
However, a bigger obstacle to an October rate cut is the timing. The RBA meeting falls on the same day as the government will unveil its federal budget for 2020/21. Announcing a rate cut on the same day as the budget is politically sensitive. But irrespective of that, policymakers would be keen to know what new fiscal measures will be included in the budget to help the economy before making up their minds on additional monetary stimulus.
RBA ponders its policy options
So if an October move is unlikely, that then turns the focus on whether the RBA will flag policy action for its next meeting, and if so, what will be its preferred option? While the Bank of England and the Reserve Bank of New Zealand are actively studying the practicality of negative interest rates, the RBA is nowhere close to considering such a policy tool.
Debelle suggested FX intervention as a possible tool in his recent speech, though that could be controversial. Realistically, the options that involve the least repercussions for the RBA are cutting the cash rate to or close to zero from the current 0.25% and/or expanding its yield curve control to beyond three-year AGBs.
Aussie at risk from easing signals
Whichever policy path the RBA decides to follow, the Australian dollar looks poised for further losses. Having just stumbled into resistance at $0.72 where the 50-day moving average is converging, the aussie could slide towards the $0.7030 area, which was the September low. Slipping below that support would open the door for the recently congested region of $0.6850.
However, in the event the RBA appears in no hurry to add more stimulus and only goes as far as sounding slightly more dovish, the aussie could bounce higher, reclaiming the $0.72 handle. Above that level, the $0.73 mark would be the next key target for the bulls.
