The RBA cut the official cash rate last week by 25 basis points. The 25 basis point cut is the first rate reduction since 2020.
The decision was in line with the consensus economist view (40 of 43 economists expected a cut according to Reuters) as well as interest rate futures pricing (~85% probability).
This cut represents the first policy change since the “final” November 2023 rate hike. That rate rise cycle took the cash rate from a record Covid low of 0.1% to a peak of 4.35% over an 18-month cycle.
| Dec-24 | Jun-25 | Dec-25 | Jun-26 | Dec-26 | |
| GDP Growth | 1.1 | 2 | 2.4 | 2.3 | 2.3 |
| (previous) | 1.5 | 2.3 | 2.3 | 2.3 | 2.2 |
| Unemployment | 4 | 4.2 | 4.2 | 4.2 | 4.2 |
| (previous) | 4.3 | 4.4 | 4.5 | 4.5 | 4.5 |
| CPI trimmed mean | 3.2 | 2.7 | 2.7 | 2.7 | 2.7 |
| (previous) | 3.4 | 3 | 2.8 | 2.7 | 2.5 |
| Cash rate (assumed) | 4.3 | 4 | 3.6 | 3.4 | 3.5 |
Source: RBA.
The politics of a hawkish cut
While the cut was widely expected (and the right call in our view), the RBA suggested it was a close call, and is arguably at odds with the RBA’s own guidance in November last year that the RBA would require more than one good inflation print.
In its statement, the RBA emphasised the better-than-expected progress on inflation (Q4 2024 CPI was lower than the RBA expected) but at the same time suggested it was a “close call”.
“The Reserve Bank Board decided to lower the cash rate target by 25 basis points, acknowledging monetary policy has been restrictive and will remain so after this reduction in the cash rate. However, the outlook remains uncertain. In removing a little of the policy restrictiveness, the Board acknowledges that progress has been made but is cautious about the outlook.”
In that respect, the RBA has acknowledged the inflation fight has not been clearly won and the RBA will be highly data dependent, with the Q1 2025 CPI print (April 30) shaping as the key test for a potential next cut at the May 20 meeting.
Last week’s cut – opening the door for an early federal election?
It will be interesting to see whether the government calls an early election in the pre-Easter March 29 to April 12 window. This would avoid the likelihood of a deflating “on hold” RBA meeting on April 1 and avoid the March 25th budget. However, it is still possible the government elects to go full term (May 17) and use a late March budget to provide some fiscal sweeteners for the electorate.
RBA Signals More to Come but Not With Much Conviction
In delivering a “hawkish cut” the RBA has likely avoided both, political pressure into an election, as well as the accusation of miscommunicating to the market were it to have stood firm with an on-hold decision. The rationale of a decent improvement in inflation and very weak GDP growth makes sense to us, albeit the RBA has been flip-flopping somewhat in its communications since November. It will be interesting to see if this clarity improves or deteriorates under the new RBA board structure.
The RBA downgraded its year-end 2024 inflation and GDP growth (see figure 1). The reality that the economy exited 2024 with inflation and growth weaker than expected supports its decision to cut. However, at the same time, the RBA lowered near-term and longer-term unemployment forecasts after a run of strong numbers. Indeed, last week’s January labour market figures were once again very strong at the aggregate level, albeit unemployment ticked up from 4.0% to 4.1% as the participation rate hit a record level.
The RBA has flagged the inflation risk stemming from a tight labour market, but at the same time has been questioning its own assumptions around what constitutes “full employment”. In RBA parlance, the NAIRU may be lower than its current 4.25% to 5.25% “guestimate”. Last week’s easing wage data (WPI) suggests the RBA might finally be on the right track concerning this question. The RBA also devoted a fair amount of space in its policy statement to the impact of “non-market” jobs growth (government related) in terms of the surprising resilience in the labour market. The economy’s highly unusual combination of weak GDP and very low unemployment is a conundrum that appears to have its explanation in the outsized role of the government in the current cycle.
The RBA has emphasised “data dependence” for more easing
The RBA will continue to monitor data on domestic demand and the labour market, as well as monthly CPI data. However, as discussed, the most important data point will almost certainly be the quarterly CPI for Q1 2025 due on April 30, ahead of the RBA's meeting on May 20 (we expect a cut).
In total, we expect a mild easing cycle of three to four cuts, taking the cash rate to a “terminal level” of between 3.35% and 3.6%, compared to its current target rate of 4.1%. This is consistent with the RBA on medium-term projections.
The economy looks to be on track for a soft landing, with a GDP pick-up likely over the next 12 months as rates ease. However, the RBA’s assumed pick-up to ~2.3% looks fairly modest by historical standards (see figure 1).
Cyclical risks that might disrupt the RBA’s central case for lower rates may come from the “tight” labour market (although last weeks WPI numbers were once gain encouraging) as well as the risk from a pre-election surge in already very strong Federal spending.
Longer term headwinds to a durable and robust expansion may come from Australia’s weak productivity, and structurally high levels of government spending, which appear to be crowding out private sector investment to some degree.
Supportive for Equities but the Market Has Pre-Empted a Lot
While risks remain, easing cycles with no recession are typically supportive for the share market. However, as we have been cautioning for a while now, the Australian market has been running well ahead of earnings over the last two years, so there is already a fair bit of good news priced in at the index level. The recent quite-significant pullback in the banking sector on the reality of lacklustre earnings growth is perhaps the key demonstration of the market’s recent overexuberance, at least at the large cap end of the market. Small and mid caps have lagged the top 20 for several years now, and are likely to be a better way to play the easing cycle in our view.
Bond and credit market implications
With our base case that the RBA cuts two or three more times to 3.6% to 3.35%, long bond yields look attractive at ~4.5% in our view.
Market pricing for cuts was pared back to only two more cuts for the cycle, but still suggest bond yields can drift down toward ~4%, or a touch lower if inflation continues to moderate and a third cut is “repriced”. However, as we have been discussing for some time, the uncertainty around the direction of the US long-end complicates the bond decision.
Floating rate public and private credit will see some crimping of absolute returns under a 75 to 100 basis points cash rate reduction cycle, but still offer reasonable total returns.
The positive of at least a modest easing cycle should keep the bad debt cycle under control and spreads relatively tight. This is supportive for higher yield public and private credit in the absence of a significant global shock.
A$ edges higher
The initial reaction of the A$ to the widely forecast RBA cut was muted, though the A$ has once again pushed higher over the course of the week against a further weakening of the US dollar. We still see the A$ as fundamentally cheap. However, the next big test could well be Trump’s tariff “review” in early April.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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