February rate cut likely but not certain: HSBC

Low inflation figures have given the Reserve Bank scope to cut interest rates when it meets on Tuesday but it might adopt a wait-and-see approach, says HSBC economist Paul Bloxham. 

Bloxham says it’s a close call because while HSBC expects to rate cuts in the first half of the year, “the issue is timing”. 

“Global financial conditions have stabilised recently, which may give the RBA more time to see the impact of earlier cuts. Also, many of the structural upside risks to medium-term inflation persist, such as weak productivity growth, so the RBA may want more evidence of easing unit labour costs before moving again. 

“So, while we think the RBA will need to cut further, cuts this month are not a done deal. What is clearer to us though is that the 100 basis points priced in by markets over the next year seems overdone, given the structural inflation issues Australia still faces,” he writes in his latest RBA Observer report. 

Putting forward the case for a February rate cut, Bloxham says inflation numbers for the fourth quarter were “low enough to give the RBA an open door to cut rates”. 

“The trimmed mean was in the middle of the band quarter-on-quarter and year-on-year, and at the bottom of the band in the second half of 2011,” writes Bloxham. 

“Base effects are likely to bring year-on-year inflation down further in the first quarter of 2012,” he adds. 

Bloxham also notes the slowdown in the economy, which has taken further pressure of inflation. 

“Employment is contracting, falling in December, and the unemployment rate is 5.2%, up from 4.9% in early 2011. Job advertisements have edged downward; a further reading for January is published on Monday, and anecdotal reports suggest it will weaken. 

“Growth is expected to ease in the first half of 2012 as Australia’s trading partners slow down and the looser labour market weakens household spending. 

“At the same time, financial conditions are tighter than they were late last year. The cost of bank funding has risen, due to the European financial crisis, putting downward pressure on bank net interest margins and upward pressure on effective interest rates. 

“The exchange rate has also been at very high levels in recent weeks, further dampening activity in parts of the economy. The fiscal setting is also tight. The government’s political imperative to achieve a budget surplus by 2012-13 is seeing public demand subtracting from the economy. 

“This leaves the RBA to respond to the easing labour market. These arguments are why we think the RBA will cut rates on Tuesday.”