Monday, 5 September 2016

August 2016 Cash Rate cut is more than likely

30th July 2016

August 2016 Cash Rate cut is more than likely

Key points:
-CPI inflation hits a 17 year low
-Money markets Overnight Indexed Swaps (OIS) are at new lows
-Government bond yields are moving into 1.50% territory
-24/25 economists surveyed believe there will be an August Rate cut
-As at Friday 29th July, the ASX 30 Day Interbank Cash Rate Futures indicated an August interest rate decrease expectation of 64% 

CPI
On Wednesday the Australian Bureau of Statistics (ABS) released their quarterly result of the Consumer Price Index (CPI) for inflation, which came in at 1.0% from June 2015 to June 2016. This sits well below the RBA’s targeted bandwidth of 2 to 3%. While the RBA do account for removing volatility when making the monthly decision on Cash Rate movements, the Core Inflation number (‘excluding volatile items’) still came in at 1.6% that is again below their targeted range. This is the lowest annualised reading since the quarter ending December 1999.

Money Markets
In the money markets, where Australian financial institutions manage their returns from borrowing and lending, the 1-month Overnight Indexed Swap (OIS) rates reached a new low of 1.623%. An overnight index swap is a swap contract for the overnight rate to be exchanged for a fixed interest rate. This indicates that Australian financial institutions are hedging to prepare their exposure to an August rate cut.

Government Bonds
The market for Commonwealth Government Securities (CGS) is yet again showing signs of a weakening economy, with negative spreads on yields between 2 year and 3 year bonds. This points to the reality that investment institutions have a preference of 3 year CGS over 2 year CGS because they expect interest rates to be lower for longer. 3 year CGS yields dipped to a new low of 1.47% below the anticipated 1.50% August Cash rate. 10 year CGS yield also hit a new low in July of 1.865%.

Predictions of Economist
In mid July, Bloomberg surveyed 25 economists to get their views on an August rate cut. These economists undoubtedly stay very tuned to the above data movements, and have based their expectations on the RBAs Cash Rate decision for August accordingly. 24 out of the 25 predict an August rate cut.

The ASX 30 Day Interbank Cash Rate Futures
On 4th July, the Melbourne Institute released their Monthly Inflation Gauge that came in at a 0.6% rise in prices for the month of June. This brought the annual Melbourne Institute inflation figure to 1.5%. The release is widely recognised as an accurate forecast for the ABSs CPI release. This low result shifted the ASX 30 Day Interbank Cash Rate Futures market to indicate an August Cash Rate cut expectation of above 50%, which later in the month reached a high of 70%.