Tuesday, 31 January 2012

Monetary Policy & Next Week's Rate Cut

Monetary policy isn't all that hard or complex most of the time.  Basically it's a decision on whether to keep rates steady, put them up or put them down.  For decisions to change rates, the question is by how much?

If there is a misreading and a policy mis-step from the RBA, they are in luxurious position where a quick correction can be made without fear or favour.

As the final drafting of the Board papers concludes about now, I suspect the recommendation will be for the Board to agree to a 25 basis points cut in the cash rate to 4.0%. 

The nuance of that cut is open to debate – of course – by the fiercely independent RBA Board.   There is some non-trivial possibility that some of the Board members will argue for a 50 basis point cut on the basis of the news since the December meeting, especially the sub-trend growth performance that has seen inflation fall sharply and employment drop.  The well-covered need for the banks to counter the higher cost of funds supports this argument.  There will also be a bit more information for the RBA to digest between the sign-off of the Board papers and the meeting next Tuesday, but this is more likely to support their action, rather than change it. 

If the RBA goes on to cut 25 basis points and it finds this isn’t enough, the door is always open for the meetings in March, April, May and into the future to cut again as needed.  From a monetary policy perspective, the difference between a 50 cut now and two 25 cuts four weeks apart is zero, other than perhaps through confidence channels and regular “good news” rather than a crunch lower in rates in one big hit.

The key issue for the RBA is that since the December interest rate cut, there has been a surprising and disconcerting deterioration in the labour market with employment falling for two straight months.  This rarely happens outside a recession.  Also, the CPI confirmed a marked deceleration in inflation over the second half of 2011 and it seems that inflation is fly-papered to the middle to lower half of the RBA target range.

Global conditions are at least as worrying as in December, even though bond yields have plummeted to levels consistent with on-going recession.  Housing remains in a funk with prices soft and new construction weak.  Business and consumer confidence are on the soft side too.

And what’s more, there is a confirmation that fiscal policy will continue to run along in a contractionary mode, a key factor reinforced by the Prime Minister, Ms Gillard.  The RBA can rest assured that its policy actions will not be thrown off course by misguided fiscal settings.  In other words, it can cut in the knowledge that fiscal policy will not add stimulus and circumvent the RBA's actions.

All up, a rate cut is all but a done deal.  

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