RBA has room to pause

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After describing both the November and December rate cuts as close calls, it is clear that the RBA would like to wait and see how things unfold.

The question is if they have the room to do so?

Recent global data has firmed up somewhat, and the muted response to European downgrades suggests that the downside risks might not be as large as feared – so it seems a better than even chance they will hold at 4.25% in February.

There are two reasons that waiting to see is good policy.

First, the cuts were (in a sense) pre emptive, so it is wise to take time to assess the forecast that motivated those cuts. All forecasts are uncertain, as are the transmission mechanisms from lower European growth to the RBA’s Aussie inflation forecast, but it is seldom that central banks have the luxury of taking time. The recent improvement in data and markets gives them time, so they should take it.

Second, waiting will give them information on the impact of the 50bps of cuts so far. We have data until November now, and the bulk of it suggests modestly sub trend growth in H2’11. This means that the unemployment rate might only have been expected to drift up slowly if they had not eased. With policy now a little easier, it is possible that things are now balanced.

What might get the RBA to cut in Feb?

Well, if the unemployment rate goes up again (out Thursday 19 Jan), core CPI is sub 0.5%q/q again (out Wednesday 25 Jan), or markets start melting down in a delayed reaction to the European downgrades (or some other shock) the RBA is likely to ease.

Still, the market is priced for 20bps of easing just now (though that is probably less than 80% as if risk aversion spikes the short end will price a small probability of an emergency cut), and unless you get a real melt down, it is not going to be more than -25bps.

My personal forecast is that the economy will slow down across 2012, and that inflation will remain tame – but that is not in the data just now. I expect more cuts to come as the data develops in this way. It just does not look like they are going to happen this quarter.