RBA Ready to Cut Rates Soon?

Although the RBA decided to keep rates on hold at 4.25% at its April policy statement, the minutes of its meeting revealed that a rate cut could be in the cards pretty soon.

According to RBA head honcho Glenn Stevens, economic growth in the Land Down Under is much weaker than the central bank predicted and that this could translate to slower inflation down the line. In that case, the RBA will have room to slash rates in order to boost the Australian economy.

Stevens also pointed out that the central bank could cut rates as early as May (Yes mate, that’s next month!) if the upcoming quarterly CPI report shows that inflationary pressures are already subdued. Analysts are speculating that if inflation stays within the RBA’s 2% to 3% target range, a rate cut could be in the works for their May statement.

Aside from weak inflation, other reasons that support an RBA rate cut are bleak economic figures from both Australia and China.

Recall that building approvals in Australia slumped by 7.8% in February, erasing the 1.1% jump seen in January and signaling that the effects of the RBA’s previous rate cuts are fading. In addition, Australia’s February trade balance showed a deficit for the second month in a row as it landed at -0.48 billion AUD.

It doesn’t help that China, Australia’s biggest trade buddy, also showed signs of weakness with its recent GDP figure of 8.1%. As I pointed out in an earlier article questioning if China’s strength is for real, several Chinese indicators such as inflation, trade balance, and manufacturing PMIs all hinted that there were a bunch of weak spots on the domestic front.

The minutes also revealed that there is growing concern within the RBA about the state of the European debt crisis, an issue RBA officials thought had died down in the past. In fact, it was improving conditions in the euro zone that helped influence the RBA’s decision to pause with rate cuts late last year.

This time however, the minutes highlight that RBA officials believe that Europe still remains as a “potential source of adverse shocks in the future.”

To me, this is no surprise. Spanish and Italian bond yields have been creeping higher lately and are making their way up to the line-in-the-sand 7% figure. Take note that when Greece and Portugal asked for bailouts, yields on their 10-year bonds were above 7%. As I said in the past, it may only be a matter of time before either Spain or Italy joins them in the bailout lunch group.

So what does this mean for the forex market and the Aussie in particular?

For now, it appears that the Aussie’s fate rests on the upcoming CPI report due next week. If it comes in to show that inflation is still within the RBA’s target band of 2% to 3%, it would give room for the central bank to cut rates at its next interest rate policy decision. This could trigger a round of Aussie selling, as lower rates give investors less incentive to purchase the Australian dollar.

Furthermore, this could have a snowball effect of ushering in risk aversion back into the markets, as market participants may take this as a sign that economic growth is at stake. Bear in mind that the Australian economy was the ONLY major economy to dodge a recession back in 2008. Thus, if Australian officials are concerned about the future prospects of their own economy, they may be good reason to be worried as well.