Rate Expectations

With the threat of bank failures, policy deadlock and recessionary clouds overhanging the world, the market in Australia continues to push down the expected level for the cash rate.

This morning, monetary policy expectations have changed to the point where the market is pricing in (rounded to nearest quarter %):

• 3.5% for March 2012
• 2.75% for June 2012
• 2.75% for Sep 2012.

In fact, the market pricing for September 2012 is a few basis points BELOW 2.75%. The cash rate is currently 4.5%.

The 3 year government bond traded at 2.99% this morning, with the 10 year yield at 3.83%. These are staggeringly low levels which are really priced for mass dis-inflation next year.

On dis-inflation, the market is correct. The December quarter CPI will be around zero - maybe negative - and underlying inflation is poised to break below 2% during 2012.

I was a touch concerned that recent RBA rhetoric was such that it was reluctant to cut interest rates too early or too far, but I think unfolding events will see it revised down its inflation forecasts again and accordingly change its view on the future path for rates. They are almost certain to cut in December and get set for more cuts in 2012. While I remain of the view that the RBA will cut to 3.5% by June 2012, the risks to this forecast are squarely to the downside.