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."

Tuesday, December 20, 2011

RBA: There was no domestic case to cut rates given "trend" growth; cut was Euro insurance

It is frankly surprising to hear some express "surprise" about how finely poised the RBA's December rate cut was. Certainly the Minutes suggest claims that the decision was an "obvious", slam-dunk one, were way wide of the mark. In the Minutes' concluding section, the Board reiterates for a second time that the Australian economy is, in fact, expanding at a "trend" (ie, not sub-trend) pace, and, more importantly, that there was no compelling case to cut rates on the basis of the domestic environment:

"Against this background, the Board considered the question of whether a further reduction in the cash rate would be appropriate following the reduction in November. On the one hand, there had been further evidence that a major investment boom was in progress and the overall economy was expanding at a pace broadly in line with trend. Australia's main trading partners were also still recording solid growth. This did not suggest any strong need to cut interest rates. Against this, developments in Europe continued to pose downside risks to the global economy and, consequently, also to Australia. These risks had, if anything, increased though the timing and magnitude of any effects that might flow from them remained very difficult to predict. In these circumstances, and given the expectation that inflation would be consistent with the target over the next couple of years (abstracting from the effect of the carbon pricing scheme), members felt that there was scope for a modest reduction in the cash rate at this meeting."

The reference to scope for a "modest" reduction in the cash rate also implies that at no stage was a 50 basis point cut contemplated, as I suspected. In a column on the day after the December decision, I argued that the move was a very difficult one to call:

"One of the smartest and most successful rate participants I know characterised it as a coin toss a day or two [beforehand]. There was a lot of money to be made going short interest rate futures if you had conviction about the RBA keeping its finger off the trigger. Right up to 1430 AEDT I was trying to clear a position [on which way they would go] in my head. I could not – I had this uneasy feeling, a little like I did right before the August decision to pause. One clear thought did come into my mind: that whatever the RBA did, we would learn more about the way they think. And that really is the key take-away."

Today's Minutes demonstrate that this uncertainty was very much echoed at Board level. And it is clear in economist reactions to the Minutes that the only rationale for cutting was for insurance purposes given the heightened Eurozone concerns. While I personally disagreed with this logic, which I had characterised at the "Stevens put" before the event, I recognised it as the only credible excuse for going (in contrast to arguments that the domestic economy gave the RBA a case). As Citigroup observe:

"The December cut was the RBA’s insurance policy. The Minutes show that the decision to cut interest rates was not taken lightly. Instead, there appears to have been some deliberation about the need to cut rate at all. According to the Minutes, domestic conditions “did not suggest any strong need to cut interest rates”. The economy was expanding around a trend rate. However, with the Board for the first time acknowledging downside risks to Australia from Europe and the risks increasing, the path of least regret was some insurance in the form of a further lowering in official interest rates."