The Reserve Bank may choose to keep the cash rate on hold in June, but AMP Capital is betting on two more 25 basis point cuts by the end of calendar 2016.
AMP Capital chief economist Shane Oliver said the Reserve Bank is “waiting for more information” before it cuts, as indicated by the minutes from the RBA board's May meeting.
“However, given the downside risks to inflation, particularly with wages growth falling to a record-low 2.1 per cent, constrained growth and the still-high Australian dollar, more rate cuts are likely,” Mr Oliver said.
“We are allowing for two more rate cuts this year, taking the cash rate to 1.25 per cent by year end.”
Since the RBA cut the cash rate to 1.75 per cent last month, Mr Oliver said, some people have argued the central bank should lower its inflation target because it cannot fight global commodity prices and should not worry about very low inflation.
“Such arguments are nonsense,” he said. “First, the whole point of having an inflation target is to anchor inflation expectations. If the target is just raised or lowered each time it looks like being seriously breached, then those expectations – which workers use to form wage demands and companies use in setting wages and prices – will simply move up or down depending on which way the target is changed.
“And so inflationary or deflationary shocks from things like commodity prices will turn into permanent shifts up or down in inflation.”
Second, Mr Oliver said that allowing very low inflation could be a cause for concern.
“Most central bank inflation targets are set at 2 per cent or so because statistical measures of inflation tend to overstate actual inflation by 1 to 2 per cent, because statisticians have trouble actually adjusting for quality improvements, and so some measured price rises really reflect quality improvements,” he said.
“In other words, 1.5 per cent inflation could mean we are actually in deflation. And there are problems with deflation.”