The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Wednesday, November 17, 2010

Surprise at "less hawkish" RBA minutes?

Financial markets evidently have very, very short memories. Prior to the RBA's shock November rate hike, there were few economists predicting rates would rise. The market was also pricing in a very low probability of a rate change. The principal driver of this consensus was an extraordinarily low Q3 core CPI print of just 0.5%, which meant that over the preceding six months underlying inflation in Australia had been running at around 2% annualised, which is at the very bottom of the RBA's target range. A second reason for the surprise in November was that the  RBA justified the decision on the basis of a "forward-looking" inflation-targeting framework. That is, it completely ignored the very low inflation outcomes over the prior six months because it was projecting higher inflation in 12-24 months' time.

The not insubstantial problem with this explanation is that myself, most other economists and poor old Terry McCrann had aggressively argued in favour of precisely this forward-looking case in October, which had the benefit of coming before the Q3 CPI print, which the RBA could have stated was not overly relevant to a decision to set rates today in order to influence price outcomes over the next two years.

Apparently rejecting this logic, the RBA said that its reason for not hiking in October was because it wanted the benefit of more information, which was universally interpreted to mean the Q3 CPI. One recent RBA alumnus, Paul Bloxham, was among the most vocal of those advancing the argument that the RBA was waiting for the next inflation numbers due to its 'policy of least regret' method (ie, you would not want to hike only to have a very low CPI result make this decision look silly after the event).

And so many economists understandably concluded that the RBA was not the forward-looking beast they had hoped, but the much more data-centric concern that purportedly got wrong-footed by two similarly low CPI prints in 2006-07.

By hiking in November, and repeatedly stating that it was taking a pre-emptive and forward-looking approach to the stetting of monetary policy, the RBA effectively shredded the logic of those who claimed it was waiting for the Q3 CPI, which, it transpired, did not influence the final decision.

The most seasoned and experienced RBA watchers had told me in October that they thought it would be inconceivable that the RBA would hike after a 0.5% core print (which was yet another reason to go in October given the optical problems you would have explaining a November decision). But that is exactly what the RBA did. This then led to the cries amongst analysts of misleading and deceptive conduct--that the RBA had lost the plot on the communications front.

Given all of the above, it beggars belief that anyone could think that the RBA's November decision was a straightforward one. Nevertheless, Dow Jones reports:

"DJ MARKET TALK: Less Hawkish RBA Minutes Weighing On AUD/USD [Dow Jones] RBA minutes not as hawkish as some expected, weighing on AUD/USD, says Roland Randall, strategist with TD Securities. "They used the words 'modest tightening' and 'prudent' and said they are taking into account moves in bank lending margins."