RBA likely to keep interest rate unchanged, expected to ease in Q3 2016

The Reserve Bank of Australia is expected to remain on hold at its monetary policy meeting scheduled to be held on July 5, at 4:30 GM. The central bank is expected to leave the official cash rate at its record low of 1.75 percent, after having cut it by 25 basis points in May.

The shocking Brexit result is likely to be an important part of the policy deliberations and include a more explicit easing bias in its post-meeting statement. According to a recent Reuters poll, 35 of 37 economists expect the RBA to keep interest rates unchanged, while anticipating another policy easing in the third quarter of 2016.

Recent Australian economic data have surpassed market expectations, with quarter one GDP gaining 1.1 percent q/q, after rising an upwardly revised 0.7 percent for the previous quarter, and the y/y rate picked up to as much as 3.1 percent. The unemployment rate remained unchanged at 5.7 percent in April. These data further eroded the chances of the RBA cutting interest rates over the near-term.

Over the past week, market volatility has subsided somewhat after the initial turmoil triggered by the surprise UK vote to leave the European Union. The Reserve Bank board will attempt to gauge the impact of the vote and its repercussions on the Australian economy.

By August, however, the combination of the uncertainty triggered by the Brexit vote and another low inflation print in late July will be enough to see the RBA cut the cash rate to a fresh low of 1.5 percent (the market is currently pricing in a 59 percent probability of an August cut), reports confirmed.

According to the RBA's June monetary policy board meeting minutes, an appreciation of AUD could complicate adjustment of the economy to the lower terms of trade. The board's decision to leave rates steady at its June 7 meeting was consistent with sustainable growth prospects. Low interest rates and the weaker AUD since 2013 have helped support above-potential growth in Q1.

Meanwhile, the federal election held on Saturday is unlikely to have a bearing on near-term monetary policy deliberations. We foresee that the central bank is unlikely to ease further until it gets another read on inflation in late July. Assuming there is no rate move at this meeting, the market will primarily focus on the accompanying comments made by the Governor for any signals about the prospect of a rate cut at one of the upcoming meetings.