The RBA’s view, by now, is well understood: trading partner growth has turned up, both export volumes and prices are boosting national income, and financial conditions are easing by themselves. As a result, the RBA has time to wait and see if their weak(ish) forecasts command further easing.
By themselves, the forecasts do require further easing. However, with commodity prices flying it’s possible to see offsetting upside risks that augur against moving now. Given the outlook, it seems unlikely that the RBA will wait more than a few quarters.
For central banks must make policy according to their forecasts — even if these forecasts are highly uncertain — and the RBA’s current forecasts just are not good enough.
The monetary policy equivalent of Maxwell’s deamon — let’s call him Taylor’s deamon — would keep growth always around potential and inflation always around trend, by moving the cash rate pre-emptively according to his economic outlook / forecasts (which would always be correct!).
This way there would be no correlation between monetary policy, the unemployment rate, growth, or inflation. The latter three macro variable would be constant at whatever the central bank wanted them to be, and all the macro-economic volatility would be absorbed by the policy rate.
This is where i part ways with analysts such as the AFR’s Chris Joye. Chris argues that the fact growth was around trend last year and that core inflation is near 2.5% means that the RBA ought not to have eased so far.
The Taylor rule can be discovered as shocks are surprises, and the central bank responds to these unexpected innovations – but Taylor’s daemon would move his policy rate ahead of the shocks, to keep demand growth around potential, and inflation on target.
Optimal monetary policy is forward looking, and aims to keep growth around potential and inflation around 2.5%. It is hard to do, as forecasting is difficult, but the best thing to do is to try.
This is why i expect that the RBA will ease further (if they do not upgrade their growth and inflation projections). A forecast of sub-trend growth and sub-target inflation will not be accepted indefinitely. The RBA acknowledges this when they note that the outlook affords scope for further easing.
When might that occur?
Well with equities up further and the labour market looking stable (at slightly weak) it seems that the next move will be in Q2 or Q3. If commodity prices spike higher following CNY (as seems probable) we could well price out all further easing before this comes into focus – and let’s face it, if commodity prices remain elevated, we might have seen the last cut until the investment handover from mining is clearly in focus.