Tim Hext: To cut or not to cut? That’s the question for the RBA

To cut or not to cut? Pendal’s head of government bond strategies, TIM HEXT, explains what information the RBA needs to make a decision

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WE are just over a month away from the next RBA meeting, the first of the year.

The information the RBA will need in order to decide on a rate cut is now falling into place. Let’s look at what we know and what pieces of the puzzle are left.

Employment and wages

Today’s employment numbers were the last before the meeting, with January’s numbers not coming out till 20 February.

An unemployment rate of 4% for the end of 2024 is definitely lower than the RBA (and nearly everyone else) expected. The RBA had forecast 4.3% by now. This, of course, counts against a rate cut but is not the end of the story.

What matters more is where full employment is, and this is not something scientific.

The US Federal Reserve believes its full employment to be around 4%, so were happy to start a rate cut cycle despite overall strong job markets.

The RBA has previously suggested that full employment here was closer to 4.5% but – as always – it is an educated guess. What is the main observable indicator? That would be wages.

On this front, the news has been far better. Wages look to be settling down nearer 3.5% than 4%, suggesting that full employment may also be closer to 4% than 4.5%.

The only large pocket of elevated wage claims seems to be public sector unions playing catch up, as their wage agreements always lag inflation.

So, on the employment and wages front, the RBA will need to work out just how much excess demand is in the job market – one still largely fuelled by the public sector.

In summary, the job and wages market is not a reason to cut, but may also prove not strong enough to stop one.

Inflation

The Q4 2024 inflation data does not come out till 29 January, but we already have around 70% of the data and a good idea on most of the rest.

We anticipate market expectations to be at 0.3% headline and 0.6% underlying for the quarter.

Clearly, government subsidies are artificially depressing headline numbers, but that is not the only news.

In the housing sector (23% of CPI), two stars of the inflation surge in 2022 and 2023 – new dwelling costs (9% of CPI) and rents (6% of CPI) – are also moderating. We expect rental cost growth to be down from 9% in 2024 to nearer 6% and for new dwelling costs to settle nearer 4%, having peaked around 10%.

This should help keep services inflation nearer 4% than 5% which, in turn, allows inflation to settle around 3% – the RBA forecast for June 2025. The fact is that inflation is somewhat circular, so as goods prices have fallen and subsidies have lowered other costs, then overall pressure comes off.

Most importantly, as consumers feel less of a cost-of-living squeeze, they are less likely to push for higher wage outcomes.

In summary, high inflation is now past us, inflation is moderating near 3%, and the need for rates up at 4.35% has now passed.

Growth

We won’t have Q4 growth numbers till early March, but we all know the story of sluggish growth, only held up and partly squeezed out by high public spending.

The RBA is forecasting a decent rebound in GDP, expecting 2.3% in 2025 after around 1% in 2024.

Growth has not been the factor keeping rates high, but rather a lack of supply in the key government areas of healthcare and social services and construction.

Unfortunately for the RBA, both state and federal governments have shown little drive to restrain their spending further. This could mean 2025 is likely to be another year where the private sector needs to make way for the government sector.

Either way, growth numbers are unlikely to be a major deciding factor for the RBA in February.

Putting the pieces together

I have avoided discussing international factors, such as Trump’s early weeks. In what might be a close decision for the RBA, these factors may yet play a part but will not be the main game.

The main game is that inflation is now back towards the top end of the RBA’s inflation range, meaning there is now space for moderate cuts.

We expect 0.25% in February (70% priced in) and 0.25% in May.

Cost-of-living relief for mortgage holders will be very welcome (especially by Albanese) and is unlikely to unleash any inflationary spending surge. In fact, the big spenders last year were retirees, pumped up with their 5% term deposit rates and strong equity markets.

I am sure they will survive on 4.5% term deposits.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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