Major bank adopts cautious approach in response to evolving economic conditions
Westpac has updated its cash rate forecast, now expecting the Reserve Bank of Australia (RBA) to begin cutting interest rates at its February 2025 meeting.
This adjustment aligns with the bank’s previous outlook but signals a conservative approach, with anticipated rate cuts of 25 basis points each quarter.
“The RBA governor all but ruled out cutting rates this year,” said Luci Ellis (pictured above), chief economist at Westpac. “This runs counter to our earlier thinking, that the process of reducing the restrictive stance of policy could start from November.”
Ellis, who was previously an assistant governor (economic) at the RBA, said the revised forecast is contingent upon economic conditions aligning with Westpac’s predictions, which sometimes diverge significantly from the RBA’s views. While Westpac’s inflation forecasts match the RBA’s August estimates, the bank is more pessimistic about consumption growth and less worried about productivity.
Westpac has also revised the endpoint for the cutting phase to 3.35%, up from the previous 3.10%. This change reflects a belief that global interest rates will remain higher than they were between the global financial crisis and the pandemic. Additionally, the RBA’s increased reliance on its own models of neutral interest rates, which average slightly above 3.1%, has influenced this adjustment.
“The underlying logic of our framework is that monetary policy works with a lag,” Ellis said. “If you wait until you are back at target before starting to cut rates from a restrictive point, you have waited too long. So, the question is how much evidence policymakers need to see to be convinced that inflation is on track to return to target on the desired timetable.”
She said that while Westpac’s trimmed mean inflation forecast aligns with the RBA’s, the RBA’s conviction levels do not currently support short-term rate cuts. The data-dependent nature of the central bank means forecasts must be revised if economic data deviates from expectations, as seen with a similar shift in Westpac’s view in April.
The RBA Review has prompted the adoption of new analytical tools and approaches, addressing full employment and the output gap. These tools, however, are untested, resulting in a cautious approach by the RBA Board.
Ellis said that most indicators in the RBA’s full employment checklist eased between May and August. Yet, the RBA’s Statement on Monetary Policy indicated a tighter labour market and economy than previously thought. Although wages growth has slowed, the RBA’s new framework appears to link full employment to the difference between wages growth and productivity growth, rather than focusing solely on wages growth, she noted.
“If not this year, the next realistic opportunity for the RBA board to begin the process of cutting is at the February meeting,” Ellis said. “Compared with now, the board will have access to two more quarterly CPI readings.
“Importantly, it will also have two new national accounts releases that will confirm that demand growth remains soft and – we believe – that the RBA’s pessimism around near-term productivity growth and unit labour costs is overblown.”
Westpac acknowledges the possibility that the RBA could maintain current cash rates longer than expected if inflation exceeds forecasts before February.
“If that scenario did occur, it is likely that the RBA would end up having to cut a little quicker than we currently assume,” Ellis said. “In wanting to be sure, the RBA board is risking getting too far behind the curve, with inflation undershooting the target and unemployment rising further than strictly necessary.”
With Westpac now revising its cash rate forecast, the Commonwealth Bank of Australia (CBA) remains as the only bank among the big four still predicting a rate cut in November this year. Westpac joins ANZ in anticipating the first cut in February 2025, while the National Australia Bank (NAB) is projecting an even later timeline, predicting the first rate cut will occur in May 2025.
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