Every Tuesday afternoon we publish a collection of topics and give our expert opinion about the Equity Markets.

As the Reserve Bank of Australia (RBA) sits for its first monetary policy meeting of 2025 today, there is widespread anticipation points toward a reduction in the official cash rate. This move is expected to offer relief to households strained by elevated mortgage repayments and to appease political stakeholders ahead of the impending federal election. However, a closer examination of Australia's economic indicators suggests that such a policy shift may be premature, potentially exposing the economy to renewed inflationary pressures and financial instability. ABSI this week argues the case against a rate cut.

The RBA holds a dual mandate for stable prices and full employment, therefore inflation and unemployment data will be given the heaviest weight. Australia's labour market continues to demonstrate robustness, with the unemployment rate steady at 4% with participation at 67.1%. This figure reflects a healthy demand for labour and any stimulation by the RBA may be inflationary. Therefore the Board’s focus will be on inflation.

Australian Labor Force Participation Rate

Source: Trading Economics

The RBA's preferred measure of inflation, the trimmed mean, remains at 3.2%, which is below RBA forecasts but still exceeds the target range of 2-3%. This persistent elevation indicates underlying price pressures that have not yet been fully mitigated. While headline inflation has shown signs of moderation, the core figures suggest that inflationary forces are still at play within the economy. Premature easing of monetary policy could risk reigniting these pressures, undermining the progress made in recent quarters.

Speaking of forecasts, while inflation is ahead of schedule, the Aussie dollar has experienced significant depreciation against a basket of currencies including the greenback. A weaker currency makes imports more expensive, contributing to imported inflation, and lowering interest rates will exacerbate this depreciation, intensifying inflationary pressures from abroad. Holding rates will likely see the Aussie dollar rally and help recede those fears.

Australia Trimmed Mean Inflation Rate

Source: Trading Economics

Looking internationally, monetary policy trends offer cautionary insights. The US, for instance, engaged in aggressive rate cuts last year but has since halted this approach amid fresh inflationary pressures which have seen CPI rise from 2.4% to 3%. If this trend continues, the Fed may be forced to reverse course and start hiking again which would be disastrous for Chairman Powell’s already weak credibility.

Despite the economic arguments for maintaining the current monetary stance, significant political and social pressures are mounting for a rate cut, especially considering the upcoming federal election. With economic management and household financial pressures likely to dominate the campaign discourse, there is an implicit expectation for policymakers to demonstrate responsiveness to public concerns. A rate cut could be perceived as a proactive measure to alleviate financial burdens, potentially swaying voter sentiment.

United States Inflation Rate

Source: Trading Economics

Financial markets have largely priced in the anticipated rate cut, with a ~90% probability reflected in current trading. It should be noted that this “probability” is derived from derivatives contracts which are primarily used by banks to hedge interest rate risk and may be skewing the market’s view on what will happen today.

While the prospect of an interest rate cut by the RBA may offer immediate psychological comfort to households and align with political imperatives, the underlying economic indicators counsel prudence, inflation remains above target, the labour market is robust, and currency depreciation poses additional inflationary risks. In this context, maintaining the current monetary policy stance would allow for continued assessment of economic trends and safeguard against premature easing that could destabilise the economy.

Nonetheless, the confluence of political pressure, public sentiment, and market expectations suggests that despite these factors the RBA is likely to proceed with a rate cut. If it does cut, I wouldn’t expect another to follow too quickly though.

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