Persistently low inflation will force the Reserve Bank of Australia to cut rates twice more in 2017 to 1 per cent, with "the possibility of unconventional monetary policy thereafter", National Australia Bank chief economist Alan Oster says.
"With inflation forecasts still very low and the RBA showing its hand as a committed 'inflation targeter', it is seemingly less worried than we thought about using up some of its valuable remaining monetary policy ammunition, the case for further cuts from the RBA appears to be mounting," Mr Oster said in a note on Tuesday.
In its recent quarterly statement, the RBA said it expected inflation to remain below the bottom of its 2-3 per cent target band until mid-2018, despite cutting rates by a quarter of a percentage point to 1.5 per cent on August 2 - a move NAB's economics team was not expecting.
The central bank also indicated that it believed the risk of runaway house price growth had diminished and that monetary policy continued to be effective in stimulating economic growth in Australia.
"This will include two more 25 basis point cuts in May and August 2017 (to a new low of 1 per cent), which should be enough to stabilise the unemployment rate (which is currently a concern for the RBA) at just over 5½ per cent."All of which added up to a strong case for further easing, Mr Oster said.
Financial markets are currently pricing in less than a 100 per cent chance of another rate cut over the next year.
Mr Oster expressed scepticism that it was the correct course of action.
"We are not as quiescent as the RBA with respect to house prices, nor are we convinced lower rates will have a material impact on inflation, [but] we do expect the RBA will react by providing further support."
Perhaps most controversial in NAB's updated outlook is the suggestion that the RBA may consider "unconventional monetary policy" should the outlook deteriorate following the projected cuts in May and August.
"The risks to the outlook going into 2018 are becoming increasingly apparent, as LNG exports flatten off at a high level and the dwelling construction cycle turns down," Mr Oster said.
"Monetary policy deliberations may then turn to the possible use of non-conventional policy measures if the outlook deteriorates further."
In July, the RBA released documents that showed the central bank's economists had been studying the impact of unorthodox policies pursued by its peers, while deputy governor Philip Lowe - who will take the RBA's helm in September - has indicated that lowering the rate on its own would lose effectiveness as it approaches 1 per cent.
Mr Oster also highlighted the risk of easier money sooner.
"Persistent weakness in CPI inflation could potentially trigger a rate cut even sooner than expected."