Rate cuts are coming and its not just because Bill said so.

I’m pretty sure that during the hysteria in May and Early June we were probably a bit of a lone voice (along with colleagues over at MacroBusiness) about the lunacy of an RBA rate hike. Any search of this site will show we constantly harp on the weakness in the household sector in contrast to the supposed mining boom.

Indeed last week in our piece (Mr Market says the RBA will be cutting rates) we said,

Overall the Consumer Confidence data is really weak and had not the RBA been so aggressive in its rhetoric a couple of months ago there would be universal calls for rate cuts. Add in a dose of uncertainty about the state of global markets and the pricing in markets doesn’t seem so outlandish.

So it was any real surprise that we saw Bill Evans change his, and by definition Westpac’s, rate call on Friday.  Indeed Bill said over the weekend,

We are now of the view that the direction of market pricing is probably correct and the next rate move in Australia will be down rather than up.

We now expect a sequence of rate cuts beginning with 25bps in December 2011 and through 2012 totalling 100bps prior to a period of steady rates in 2013.

Wow – that is a big flip from his call for a June hike after the May Statement on Monetary policy. But is it credible?

You won’t be surprised to hear me say I think the call for an easing is certainly credible based on the outlook and outcomes in the economy that we have chronicled for many month’s both here and in other spaces.

Bill got caught with the June hike call by the RBA’s aggressive rhetoric. Indeed I had heard him vehmently defend consumers and households against any further hikes only two days before the release of the SoMP. So I was really surprised when he made the call for a hike and argued with some old Westpacian friends that as the Senior Australian Market Economist Bill should have been saying the RBA was wrong (I highlighted this exchange in our May Monthly).

I think he just got head faked by Governor Stevens strangely aggressive rhetoric and my bet would be that like us, he is still scratching his head as to what on Earth they were thinking at the time.

So hats off to bill for not becoming wedded to the silly rhetoric and changing his call when he thought things had changed.

The question of when the cycle starts is more problematic however.

Bill seems to be hanging his hat on some sort of further deterioration in overseas markets as the catalyst to start the rate cut cycle when he says,

the catalyst for the first rate cut is likely to come from offshore


we do not expect it to be a one off. Interest rates are too high in Australia given the state of the non-mining sectors of the domestic economy and a downward adjustment is required to avert a damaging round of contraction. This rate adjustment is likely to take a similar form to previous easing cycles.

I know for certain that if we get a conflagration in offshore markets we will definately get a cut in Australia. A dislocation on top of an already weak domestic economy would be too much to bear. The question of whether it is going to happen though is more problematic.

I didn’t think rates were going to go up any more and as I highlighted last week I thought the market pricing cuts seems right without the aggressive RBA rhetoric but neither did I think the RBA would cut this year, as Bill does, unless we see a blow up in Europe.

But we shouldn’t get caught up on the when it starts, or even the if, because Bill has changed the game and markets listened Friday afternoon as futures rallied and the AUD sold off in anticipation of lower rates. We know, because they tell us often, that the RBA also listens to the market – so the outlook for rates is stable at worst now.

Hopefully more market economists will start to focus on what we have been saying for some time now – households are suffering and the mining boom is just not filtering through to the rest of the economy. We have cautioned ourselves about getting too bearish now that the data is printing the way we thought it would and the market is recognising the weakness that we have seen for months.

But uncertainty is poison to an economy and the cumulative impact of too much debt, household retrenchment, disappointment that the boom we were promised never materialised for most Australians, weakness and instability offshore, falling house prices and now the uncertainty around the Carbon tax all point to an even weaker outcome than we had thought possible.

I fear Australia is talking itself into a recession – the RBA is going to cut rates, its just a matter of when.

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