The best summary I have seen so far...
"Could it get more complicated than this? We think not. Forces are pulling the economy every which way, and all at the same time.
Inflation is rising and expected to continue to pick up, the mining boom continues, the non-mining parts of the economy have weakened and, as markets have shown over the past day or so, tail risks of a large negative financial event are acute.
Importantly, policy settings seem to be being set, more than ever, by weighing up the balance of risks around the central forecasts, rather than based on the central forecasts.
Today’s statement reiterates that the Board remains committed to ensure that inflation remains ‘consistent with the 2-3% medium-term target’ but, at the same time, the inflation forecasts have been revised up so that underlying inflation is expected to be above the target band for the next two and a half years. What gives?
The rationale surely relies on the fact that, while this is the RBA’s central forecast, the distribution of risks around that forecast are skewed (presumably heavily) to the downside. In this environment the RBA has determined that the ‘policy of least regret’ has been to hold steady. Tuesday’s decision to hold rates clearly reflected the acute financial market fragility, and things have gotten worse in the past day or so.
So the next decision is very dependent on how that balance of risks plays out. On the one hand, if global financial conditions get significantly worse, and particularly if we start to see this in macroeconomic conditions, the risks will start to move the RBA’s central forecast for inflation, perhaps obviating the need to raise rates. On the other hand, if the current market dislocation is temporary, or an overreaction, this could see the RBA lifting rates soon, as its central forecast demands.
Another key moving part here is the likely policy response to a significant downturn in developed markets. The risk of a QE3 type programme must have increased in the past few days. This sort of policy action has tended to support, if not boost commodity prices and inflation, particularly in emerging Asia. Clearly, higher commodity prices boost Australian incomes and also put further upward pressure on Australian inflation. So it is worth considering that, while the current global financial disarray may see weakened sentiment, which would also affect Australia, it could also see higher commodity prices, which would push up Australian inflation further. This is quite a conundrum. "
