The Reserve Bank's economics department had a bad year in 2011, and as a result the board is now high and dry with an official cash rate that is obviously wrong. It needs to come down by 0.5%, to 3.75%, next week.
In its February 2011 Statement on Monetary Policy, the RBA had a GDP growth forecast for the year ended December 2011 of 4.25% and for June 2012 of 3.75%. CPI inflation for June 2012 was forecast at 2.75%, the same as underlying inflation.
But then in May the bank's economists came over all bullish and upped their GDP forecast for June 2012 to 4.25%, while leaving the December forecast at 4.25%. CPI inflation for June was cut to 2.5%. In August the GDP forecast was up again to 4.5% and while the CPI forecast was left at 2.5%, the underlying inflation forecast was jacked up to 3%.
In November wobbles started to appear and the GDP forecast was cut to 4% and underlying inflation back to 2.5%. In February this year the GDP forecast for June 2012 was back to 3.5% but underlying inflation was actually raised to 2.75%.
So the RBA's economists have made two big mistakes: they got 2011 GDP growth horribly wrong and raised their inflation forecast in February for this financial year even as GDP was falling short.
It's hard to know what came over them on GDP in May last year, but the statement was especially bullish about commodity prices and resource and farm exports. Maybe they were influenced by Treasury, which had a GDP forecast for 2011-12 of 4% in the May budget last year, which has also turned out to be wildly wrong, leading to a bigger than expected deficit (by almost $10 billion).
But why the RBA felt the need to be more bullish about economic growth than Treasury in the middle of last year will probably have to remain a mystery, but that rush of blood to the head in May is still dogging the Reserve bank governor, Glenn Stevens and his board.
With GDP growth of 3.5% and underlying inflation of 2.75% in their February SMP forecasts for 2012, the board could hardly cut rates then, no matter how hard the business people on the board were arguing for it.
The minutes for the April meeting drily say: "Members noted that the national accounts for the December quarter had shown an increase in real GDP of 0.4% in the quarter and 2.3% over the year, which were both lower than expected."
Well, yes, that's an understatement – as recently as November the economists were forecasting 2.75% growth for 2011; just six months earlier they'd been forecasting 4.25%! That's almost twice reality.
One can imagine a fierce debate in the April meeting between the business people and the economists, with the latter clinging to the last shreds of their dignity. In the event they persuaded the board to wait for the March quarter inflation figure before cutting rates and hanging them out to dry.
Kerplunk! March quarter CPI inflation was 1.6%, against last November's forecast for the year to June of 3.25% (there wasn't a forecast for the March quarter). By February that had been slashed to 1.75%, but even that now looks too high.
Next Tuesday it will be, or should be at least, a bedraggled, hangdog group of economists who shuffle into the RBA board meeting for their presentation. And many of the board members may well be checking their emails while it's going on, having already made up their minds to cut rates by 0.5%.
Today I am going to dive into two controversial issues: whether the RBA “should” cut rates by 25 or 50 basis points next week, and what I call the “great RBA counter-factual”. That is, what Australia’s inflation rate would have looked like had the RBA not made its many purported policy “errors”.
Let’s deal with the second issue first. You have to pity our inflation-targeting central bank. You get consistently high underlying inflation, and you get slammed. You do the job you were given, lift interest rates, and allow the currency to appreciate (as you expected), and you get some low inflation. Just what you were shooting for.
And, by the way, “low inflation” is not something Australians are used to seeing. It’s not even really that low – still above the bottom of the RBA’s target 2% to 3% per annum band – and when you strip out “internationally traded” good and services, you find that Australia’s “domestic” inflation looks pretty ugly. But you still get slammed again. According to Alan Kohler today, you will be a “bedraggled, hangdog group of economists who shuffle” into your board meeting next week.
Apparently you made a huge mistake delivering what you were supposed to: much lower tradeables inflation, which is the only reason overall Australian inflation has been wrenched back down towards the bottom of your mandated zone.
Yep, because of the RBA’s decisions, Australia’s economic station looks horrific: we’ve had the first mining boom in recorded history without a major inflation outbreak, 5.2% unemployment, interest rates around their long-term averages, business surveys that suggest growth is near trend (as does the unemployment rate), and underlying consumer inflation of 2.2% per annum, which is still above the targets of most other central banks.
There is an enormous amount of circularity in the current debate about Australian inflation and interest rates. Contrary to popular myth, the latest inflation results are not a disaster. They are the very pleasing and expected result of the RBA’s considered policy actions.
Let me put prove this point graphically. If you compare inflation in "domestic" goods and services (called "non-tradeables"), which also happen to be things that we tend to buy more frequently (and are associated with “cost of living” perceptions) with inflation in so-called "tradeables", which are those goods and services that the ABS defines as having their prices determined in global markets, you will see that almost all the reduction in Australian inflation has been driven by these global consumer prices. And the reason these prices have been falling is because of the appreciation in Australia’s trade-weighted exchange rate, which is one of the RBA’s two key policy tools.
This is illustrated strikingly by the blue line in the chart. Overall inflation is a combination of the blue and red lines. What you can see is that inflation in non-tradeables (i.e., domestic items) remains way above the RBA's target, and is in line with its average 3.7% per annum rate since December 2001.
So this is where the debate about interest rates and inflation becomes circular. Those arguing for much lower interest rates, and a much lower currency, are, by definition, comfortable with higher tradeables inflation. A big decline in the currency would reverse-out a lot of the deflationary benefits yielded by the blue line slumping in the chart above. And without this tradeables deflation we would likely have an overall inflation problem, given domestic consumer prices have been expanding at 3.5% per annum.
One of the reasons "tradeables" inflation has averaged only 1.7% per annum since 2001 is because our main trading partners, such as China, were flooding our markets with cheap imports – that is, exporting deflation. This dynamic has slowed due to rising wage costs and inflation in China and India. As the RBA has observed (and I’ve argued here for years), China is now a source of inflation rather than disinflation. That means that in the future, tradeables inflation will likely be higher than it was during the 2000s.
A related question is whether core inflation of 2.2% per annum, or lower, is such a bad thing. What has happened to core inflation in Australia since the RBA began targeting it in 1993? Is there any evidence we’ve had a structural inflation problem?
And, on a more nuanced level, what does the distribution of inflation outcomes since 1993 look like? That is, does the RBA struggle to keep core inflation around the mid-point of its already high and wide (by international standards) 2% to 3% per annum target band? Do we have a bias in Australia towards high rather than low core inflation outcomes?
To try and answer these questions I have started with a chart that illustrates Australia’s core inflation rate on a three-year and five-year moving average basis since 1993. This suggests that during the 1990s and 2000s there did indeed seem to be an upward drift in underlying Australian inflation. The RBA has acknowledged as much, conceding that it finds it hard to forecast high core inflation events. (The same phenomenon was also found in consumer inflation expectations, which is arguably more worrying.)
A possibly more interesting analysis is to measure the amount of time Australia’s core inflation rate is above or below the mid-point of the RBA’s target zone. I’ve done this for two periods: since 1993 and since December 2001 (i.e., after the introduction of the GST) in my final charts.
The results are remarkable. Over the last decade plus, core inflation in Australia has been above the mid-point of the RBA’s target 2% to 3% band an extraordinary 92.9% of the time. It has been above 3% per annum an equally amazing 33.3% of the time. It has been below the mid-point only 7.1% of the time. And since 2001 it has never been less than 2% per annum (year-on-year rolling quarterly). That will hopefully change next quarter.
If we examine the RBA’s track record over the full inflation-targeting period of March 1993 to March 2012 we find similar results: core inflation has been less than 2.5% per annum only 35.1% of the time, but above the mid-point 61% of the time (there have been three quarters in which year-on-year inflation was exactly 2.5%).
This strong asymmetry in Australian inflation, whereby it tends to overshoot rather than undershoot the target, is also evident when we look at the top and bottom of the band. Whereas core inflation has been above 3% per annum around 20% of the time over the last 19 years, it has been below 2% per annum only 8% of the time.
Inflation is a tax on your purchasing power and savings. That’s precisely why the central bank’s job is to keep it low and steady. Having a core inflation rate of around 2% per annum when it is being driven almost entirely by tradeables deflation, is a good policy outcome whilst non-tradeables inflation is running at 3.5% per annum.
With that explanation behind us, let’s think about the RBA’s May meeting. The arguments in favour of a 50-basis-point cut are obvious and simple: the RBA’s made a terrible policy error, is now behind the inflation curve, and it needs to slash rates, and pull the currency down, to save trade-affected industries.
Another argument is that the RBA will not want to cut after the budget for fear of being seen to be endorsing the government’s decisions.
The arguments against 50 basis points, and in favour of a one quarter of a percentage point cut, are more nuanced (and accurate). The first is that a 50 basis point move signals the RBA has made a mistake, and undermines its credibility.
A second is that if the RBA wants to genuinely stimulate the economy, it will get more bang for its buck by spreading the cuts out over multiple months and maximising the “jaw-boning” effect.
I’ve talked a lot in the past about the virtual rate hikes we had in 2011 care of the RBA regularly beating the inflation drum, which everyone seemed to accept. The same is true in reverse, but most commentators appear to have forgotten. The media can get the community all excited about interest rate relief in May and June, rather than just in May alone. It’s smart psychology.
A third reason to go 25 rather than 50 is a very poorly understood problem that a big cut creates for the banks. I was speaking to the treasurer of a bank about this issue on Friday. He said to me, “God, I hope the RBA goes 25 and not 50.” I was a little surprised, and asked him why.
He explained that because all the banks have so much retail money tied up in term deposits these days, and because their variable-rate “wholesale funding” prices off the three month bank bill rate, a sudden cut in rates actually damages bank profitability. That’s because the banks cannot immediately reduce all the retail deposit and wholesale funding rates for existing funders.
So, perversely, by cutting 50 you are actually going to encourage the banks to pass on even less to borrowers to save their margins because they cannot immediately reduce their funding costs by the same amount as the RBA’s cash rate change. This bank treasurer argued that all Australian banks will have the same problem.
A final obvious reason to go 25 and not 50 is that you get the benefit of much more information. You get to evaluate the budget, see the next round of unemployment and labour cost data, watch the reaction of the currency, and then re-calibrate your growth and inflation forecasts. And a one month delay is not going to make a material difference to the economy.
Of course, exactly what the RBA does on Tuesday is harder to call. The six business executives on the board will probably opt for the simpler story that says the RBA has to slash rates by 50 to save the economy from low inflation. They would be wrong.
Any rate relief from the Reserve Bank next week is expected to help stabilise home prices, but a rebound may still be some way off.
Investors are currently tipping a 100 per cent chance of a 25 basis point rate cut when the Reserve Bank meets on Tuesday, which would take the cash rate to 4 per cent from its current level of 4.25 per cent.
Additionally, the market sees a 30 per cent chance of a 50 basis point cut when the RBA meets, as it responds to a slowing domestic economy.
The vast majority of economists polled by Bloomberg - 27 out of 28 - tip a 25 basis point cut next week, while one economist, Citi’s Joshua Williamson, foresees a 50 basis point cut.
ANZ real estate economist David Cannington believes that even with two interest rate cuts, home prices will be 2.5 per cent lower at the end of 2012 than at the beginning.
“A lot is going to be driven by confidence in the housing market, which is really going to take a while to recover, especially with the weak employment growth we had in 2011,” he said.
Official RBA rate cuts will help improve affordability and confidence in the housing market, analysts agreed. House prices, have slid 4.4 per cent in the year to March, according to RP Data.
But enough worries about the outlook for the economy persist to keep home price growth subdued in the near term. Also, the poor affordability of housing in Australia is considered another hindrance for growth.
Westpac senior economist Andrew Hanlan said outright home price increases looked unlikely following any rate cuts.
Even some former insiders are questioning whether the Reserve Bank has got its sums right.
The Reserve Bank was the toast of the financial world a decade ago. Australia had notched up its 11th year of economic growth in a row after dodging the 2001 ''tech wreck'' recession, and the international plaudits were flowing in.
In September 2002, the governor Ian Macfarlane was crowned central banker of the year by Euromoney magazine. It credited the economy's performance to his foresight, and luck.
A few years later, Macfarlane was mentioned in media reports as a potential replacement for the US central banker Alan Greenspan.
Fast forward to today and it's a very different story.
The RBA governor, Glenn Stevens, who took over from Macfarlane in 2006, has earned widespread praise from economists for his decisive response to the global financial crisis and the mining boom since then.
But after this week's shock news that headline inflation was just 0.1 per cent in the March quarter, economists have joined some business leaders in openly criticising the central bank board's reluctance to cut interest rates.
''I think at the end of the day they've got it wrong,'' the AMP Capital chief economist, Shane Oliver, says. ''They were right in the way they were saying that the risks of Europe had receded, but they were wrong in missing the weakness in the domestic economy.''
Solomon Lew, a retail magnate and former RBA board member, claimed last month the bank was out of touch, and this was seriously hurting the biggest private sector employer, retail.
''I have a view that they are not in touch with the market and don't understand where the economy is at the moment, there is a big danger in the amount of jobs being lost and that has put a dampener on the economy,'' Lew said.
The housing and manufacturing industries have been just as strident - the prominent unionist Paul Howes has called for a debate on the RBA's charter.
Criticism for not cutting interest rates is inevitable from sectional interests, of course. But even some former Reserve insiders now acknowledge the bank appears to have overestimated the threat posed by inflation.
Professor Bob Gregory, an RBA board member between 1985 and 1995 and an economist at the Australian National University, says it now seems clear the boom has not spread through the economy as much as the Reserve expected.
''In retrospect, I think the bank probably forecast a bigger boom than we've got,'' Gregory says.
He stresses that the RBA cannot "flip its policy around one month to the next," and no one is perfect, but also adds: ''Having said all that, it's quite clear that interest rates have to come down because it does look as though the inflation forecasts are out of kilter.''
Raising more questions about the RBA's ability to set lending rates, the big four banks have made it clear they now intend to set mortgage rates independent of the central bank.
So has the Reserve lost its mojo?
Among experts contacted by Weekend Business, there are concerns the Reserve has made two main mistakes: it overestimated the effect of the mining boom while underestimating the weakness of consumers. Others disagree, saying the bank has been right to sit on the sidelines.
The property market is begging for a cut to the official interest rate tomorrow, but experts warn everything depends on the big four banks, and whether they will decide to follow the Reserve Bank’s actions.
The comments come as the auctions market dropped to a new low in Sydney, while remaining steady in Melbourne, although listings are still well under the same levels recorded last year.
According to Australian Property Monitors, Sydney recorded a 48.8% clearance rate with 271 listed auctions – one of the lowest rates in the past few years.
The Real Estate Institute of Victoria recorded a 60% clearance rate with 520 auctions reported, just under the 544 listings recorded this time last year. Chief executive Enzo Raimondo said the outcome was “very consistent”, and noted the upcoming RBA announcement has the opportunity to turn the property sector around.
But experts aren’t so sure. Although a 25 basis point cut is all but assured tomorrow, SQM Research managing director Louis Christopher says the banks’ decision to decouple themselves from the RBA’s movements means it’s harder for just one announcement to make a significant impact on confidence.
“Let’s assume we do get a rate cut, and the odds are that we will. But how much of that is going to be passed on? If they only pass on a fraction of it, less than half, it’s not going to do much for the market.”
“All it will actually do in the minds of buyers is confirm the amount of clout the banks have now. And that’s scaring off a lot of people.”
There is some positive news for buyers, as Westpac announced it would cut mortgage rates ahead of tomorrow’s decision, providing a discount for loans between $150,000 and $250,000. It has also cut fixed one-year and three-year home loan rates.
However, the bank has said it cannot confirm at this point whether it will pass on any rate cut in full.
Housing Industry Association chief economist Harley Dale says this is the main issue. Although movements from the RBA are “helpful…they are not some kind of panacea to address weakness in the housing market”.
In addition to further movement from government to provide stimulus, Dale says the RBA will need to provide more cuts than usual – perhaps even 75 basis points over the next several months – for the banks to adjust their rates by enough to kick-start the market.
“If you get 75 basis points’ worth of cuts from the RBA, you may only get 50 points of relief for home owners. I think that would be sufficient enough to provide a helping hand.”
Dale’s comments also come as the HIA releases its new home sales report, which shows the market has continued its decline.
However, there is a spark of hope as economists predict the RBA will have no choice but to move tomorrow, following last week’s feeble inflation data.
CommSec economist Craig James predicted last week there is an “ironclad” cause for the Reserve Bank to cut rates by at least a quarter of 1%.
In talking about the RBA’s meeting this week (decision due Tuesday at 1430 AEST) and beyond, there are a couple of ways I could approach those CPI numbers that we saw last week. I could of course take the path that many others choose – especially the growing army of pseudo-economists and ALP propagandists in the blogosphere (the day of electoral annihilation is near at hand). But using double speak, dismissing facts and spinning lies, as well worn as that path is at the moment, isn’t my thing – no need. The CPI was high and the genie is out of the bottle! But of course it wasn’t and the only people who are fooled by such tactics are those who use them.
Inflation is certainly lower than expected, and that has all manner of people writhing in glee about just how weak the economy must be. We ARE in a recession – see, I told you! Low inflation proves it! Unfortunately, and I do hate to cut the schadenfreude short, these views are based on a seriously flawed understanding of economics. The latest first quarter CPI numbers only confirm what I pointed out after the fourth quarter numbers – and that is that the factors that are dampening inflation are all temporary.
By now you know the drill. Lower inflation is literally due to currency impacts and food. In the absence of the correction from the floods – which is a supply side phenomenon – and the extraordinary falls in some currency sensitive areas, CPI was up 0.8 per cent, non-tradeable up 1 per cent (around 4 per cent annually). This acceleration in demand induced inflation is entirely consistent with domestic demand growth at its strongest in four years and an unemployment rate around 5.2 per cent. All the data is consistent. Overall CPI is low, sure, and on my estimates, true underlying inflation is running at 2.5 per cent (I’m not referring to the ABS’s measures here). This is a good outcome, but there is nothing in these estimates that should encourage complacency when the risks around the growth are to the upside and evenly balanced with regards to CPI – especially when the modest inflation now is largely due to supply side factors (heavy rainfall, changes in technology and the high Australian dollar).
This is a reasonable observation to make. Almost without exception price falls, or at least the magnitude of them were unusual, but they are temporary. On the flipside price gains were not unusual – they were very normal. So unless you think the exchange rate will continue to rise at about 5-10 per cent per quarter, then this impact will wane. Also consider that it is highly unlikely that fruit prices will continue to fall by 30 per cent per quarter. In contrast pharmaceuticals will continue to rise by 10-15 per cent, education by 5-7 per cent, rent by at least 4 per cent per year, etc. Non-tradeable prices, remember, accelerated in the quarter, rising 1 per cent – they are up nearly 4 per cent for the year. There is no disinflation here. Consequently it is disingenuous for anyone to claim that underlying inflation pressures have eased materially when clearly they have not. When lower CPI is due to only a few components, no broad based move.
Unfortunately there will be little recognition of this when it comes to the policy debate. The economic debate has been farcical in Australia for a very long time and the board, as biased as it is with manufacturing representatives etc, will cut for sure. As I discussed after the RBA board minutes, it was clear that even prior to the latest numbers, that a 25 basis point cut was basically baked in. This was clearly the case after the board lowered the bar to a cut by dropping the requirement that we see a material weakening in demand (which we have not).
So misleading has the discussion become that most people were pressing for rate cuts even while forecasting core inflation to be at the mid-point – with the unemployment rate as low as it is and with domestic demand at a 4-year high. People were actually arguing that even a high CPI wouldn’t, or at least shouldn’t, stand in the way of a cut. As regular readers know I think these ‘arguments’ only show that the policy discussion has had very little to do with actual economics or the state of the nation. Demand is strong, this is not debatable, yet people say the economy is weak, pointing to GDP growth – the RBA got it wrong you see. Umm, no, the pessimists got it wrong and clearly can’t read. GDP is only weaker than expected due to the extraordinary growth in imports, and the weather affecting exports. Full stop.
This all highlights one simple fact – people just want lower rates; rate cut hysteria is extreme. They want lower rates too boost the popularity of a weak and unpopular government, to boost profits, lift margins and lower the Australian dollar. Just quietly the Australian dollar is up to 1.0460 or what, about a cent and half higher than what is was before the CPI. Again, there's no recognition of this or understanding from these people as to what is actually driving the Australian dollar higher.
So we’ll get those cuts and as many have said the only question is whether it’s a 25 or 50 basis point cut. For mine, I think a 50 basis point cut would be way over the top and panic people. Note that business and consumer confidence actually fell the last time the bank cut rates, because of confirmation bias – you know, things must be bad if they are cutting. If the board can understand this, we’ll get 25 basis points this month and maybe another in June. Make no mistake, any rate cut from this point is in my judgement a mistake. If the cash rate was 50 basis points higher, then a cut might be in order. But it’s not. I mean, this more modest inflation environment now probably does allow an easier monetary stance (4.5 per cent), but I’m not sure the outlook does given the lags of policy. How many rate cuts? Given the extent of the hysteria I’d say at least 75 basis points but that’s a guess. It’s difficult to forecast what the bank will do when the debate is detached from reality.
More on all of that later. For the rest of the week and outside of the RBA’s meeting there are only a few bits of data for Australia. TD securities inflation gauge is out today (1030 AEST) as is the RBA’s private sector credit numbers. RP Data Rismark’s house price series is due tomorrow and then on Friday we have the Reserve Bank’s Statement on Monetary Policy, which will outline the new growth and inflation forecasts. I’d be surprised if there is much of a change in the growth forecasts, but inflation will likely be revised down maybe a quarter to half a per cent in 2012, although again, I wouldn’t have thought inflation forecasts beyond 2012 would have changed much, but they probably will be revised down a quarter of a per cent or so to justify the rate cuts we’re about to get.
In the US, it’s action packed as usual and some of the big releases worth watching include personal income and spending tonight, which also gives us an estimate of what the core PCE (Fed’s preferred inflation measure) did. On Tuesday night we see construction spending and the ISM manufacturing index, then factory orders Wednesday, initial jobless claims on Thursday and the big one – payrolls on Friday. The market looks for a 165,000 gain in April payrolls while the unemployment rate is forecast to remain steady at 8.2 per cent. Otherwise German retail sales and China’s manufacturing PMI (Tuesday at 1100 AEST) are probably worth a look.
It's funny - everyone seems to think 25 points is assured, 50 is possible. And yet the dollar is looking very strong. I would have expected it to wobble about now.
But I can't see rates not falling. Is this just press hype? The RBA could be lynched if they don't cut.
Whenever you have an argument with someone, there comes a moment where you must ask yourself, whatever your political persuasion, 'am I the Nazi?'
The debate surrounding the probable size of the rate cut at the RBA’s May meeting has become a little weird. Well qualified economists are saying things that sound more like pop-psychology than economics.
Economists, in general, make terrible psychologists. Thus, I do not rate (at all) the argument that the RBA will not cut 50bps as it might hurt consumer confidence. I am quite sure my Mum is not going to call me asking if she should be worried on Tuesday afternoon if the Bank eases by 50bps …
I am certain the RBA will discuss a 50bps rate cut at their 1 May meeting, and I judge that a 50bps cut is more likely than a 25bps cut. The main reason – the RBA needs to cut by more than 25bps just to get easy.
Reading the RBA’s April statement and minutes, it seems clear that the RBA’s April meeting ended with agreement that the economy had been weaker than they expected. Following on from this, the board seems to have agreed that weaker growth meant that the output gap was most probably a bit wider and that the medium term inflation outlook was likely to be a bit lower than they had previously judged.
Given the ongoing productivity puzzle, there was uncertainty about this last part (the medium term inflation outlook) and therefore the board wanted to see Q1 CPI to help judge the extent to which slower growth was likely to mean weaker inflation.
With Q1 CPI in hand, the Board not only has the most up-to-date read on the pace of inflation, but also more information about the supply-side of the economy. Both will have helped them firm up their assessment of the medium term inflation outlook.
My guess is that the inflation print will have challenged the RBA staff. Inflation is not just weaker than expected – it’s too low. There has been no inflation for two quarters. The weak supply side story we have all been telling now seems to be fatally damaged.
The new information makes it fairly clear that inflation has been running at ~2.25%y/y pace, on average, for the last two years. The higher readings in H1’11 appear to have been supply-shock related, and at least some of the recent weak readings appear to be the unwind of that supply-shock.
Some have said that the RBA will look through it as it’s ‘just food’ – but that’s not the case. If you look at the ex food and fuel, and ex volatile measures, they tell broadly the same story (note: I seasonally adjusted these measures at the aggregate level to make them comparable with the WM and TM measures, which is fudging bit).
In my judgement, the risk is that the underlying inflation pulse is actually a little lower than 2.25%y/y. The average over the prior two quarters is ~2%y/y pace, and with the economy sub-trend, and the output gap widening, inflation seems more likely to slow further than accelerate. Look at the down-trend in the ‘four core’ average, shown above – there’s something going on.
With inflation running at least 25bps below prior RBA expectations, and decelerating, the RBA needs to ease policy by 25bps, just to get the real cash rate down to the level they had previously thought they were at. That is, they must lower their rate by at least 25bps due to the inflation under-shoot, just to ease back to where they figured they were a few months back.
To this, we must add the cut they signalled in April to do due to the growth undershoot (so long as inflation was moderate). For mine, this means (at least) two cuts. If you know you want to be 50bps easier, what’s the wait?
In any case, if you want to get 50bps through to borrowers, you are probably going to have to cut by 75bps – as the Banks will soak up ~20% of any easing.
Zooming out for a moment, the most likely explanation for the recent growth-inflation performance is that monetary policy has been tight. I suspect that the neutral RBA policy rate is modestly lower than the present rate — say ~4%, or perhaps a bit lower. So if the RBA wants to be ‘stimulatory’ they are going to have to cut by more than 25bps.
Other factors suggest to me that the RBA has more than 50bps of easing to do. With the UK back in recession, Euro Business indices turning down once again, and US data also slowing, their global growth outlook probably needs to be revised lower. Similarly, financing markets have become a little more difficult, in recent months.
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