The start of an easing cycle is upon us, but the path forward remains unclear, much like the post-pandemic economy. The debate now shifts from when the cycle commences to where the terminal rate for this cycle might land. Nonetheless, the first interest rate cut since November 2020 marks a definitive turning point for market sentiment and its impact on risk assets.
Rationale for the Cut
The RBA's decision for a 25bps cut reflects a view that inflation is sustainably moving back towards the Bank's 2-3% range. Three consecutive declines in quarterly core CPI from 4.0% to 3.2% in the December quarter afford some space for monetary easing.
In the February statement, the Board also highlighted some weakness in the demand side of the economy, with consumer and business sentiment subdued. Noting that "there has also been continued subdued growth in private demand and wage pressures have eased".
The Board was careful to point out that upside risk remains, suggesting that the labour market may be tighter than previously thought. So, while today’s policy decision recognises the progress on inflation, the Board remains cautious on prospects for further policy easing.
While Australia's economic stability presents minimal recession risk, the RBA must balance stimulus against potential overheating concerns from ongoing fiscal spending, as our economist Michael Knox points out in his recent piece.
What is priced in
Before today's announcement, futures implied a further 50bps interest rate cut, taking this cycle's terminal rate to 3.6% by December 2025. The RBA's forecast assumes three further cuts by June 2026 and a terminal rate of 3.4%. Given the uncertainties around the path of inflation, we think the RBA’s comments will unlikely alter the market outlook for interest rates.
Updated Economic Forecasts (Feb 2025)
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Michael Knox is more cautious and believes there is limited scope for further rate cuts until unemployment rises from 4% to around 4.6%. The situation is complicated by fiscal policy. The Labor government has been expanding employment in sectors like the NDIS and other areas of the public service. This fiscal stimulus is preventing unemployment from rising to the level needed for inflation to fall. As a result, unemployment remains stuck at around 4%, and inflation remains too high for the RBA to cut rates further.
ASX performance following the first RBA rate cut (1996 – 2021)
The impact on investor sentiment is clear - historically, the ASX 200 has risen by an average of 4% in prior cycles since 1996 when the RBA proactively cut interest rates, excluding the periods of the Global Financial Crisis and the COVID-19 pandemic. As per prior cycles, we think this marks a definitive turning point for sentiment and is likely to support the positive underlying momentum in the equity market.
However, at a sector level, performance is mixed - Industrials, Healthcare, and Utilities generally outperform the ASX 200 in the three months following the first cut, while Financials, REITs, and Energy tend to lag.
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Market implications
The multiples being paid by the market, particularly for interest rate-sensitive sectors, are high (ASX Industrials c22x vs the 10-year average of 19x), suggesting that some level of interest rate easing is already factored into prices. The prospect of two further rate cuts will help sentiment but is unlikely to create a step change in earnings forecasts. Every cycle is unique, so positioning is key for us, especially around industries and stocks that are best placed to benefit from this easing cycle.
Banks
A lift in front book volumes and more-buoyant mortgage demand needs stronger anticipation of lower product rates than a modest start to easing would bring at this stage. We still struggle to find value across the major banks (CBA – no major upside surprise supporting the price).
Consumption
Assuming a terminal rate of 3.60%, this equates to a savings of ~$300 a month for the average $666k loan size (ABS housing finance). This is expected to provide a modest boost to household consumption but the full impact is unlikely to be felt until 2H FY26. We prefer consumer linked stocks tied to lower-valued products (UNI, LOV) over housing-linked exposures at this point in the cycle.
Best ideas
Universal Store, Lovisa, Webjet Group
Property/Housing
As borrowing capacity improves, the housing market could see increased activity in lower-priced segments, alleviating some affordability issues that persist and offset inflation that is still evident in the cost of building. Banks are likely to actively promote fixed-rate mortgages ahead of potential further cuts.
Best ideas
James Hardie, Qualitas, Maas group
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