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Saturday, January 21, 2012

Ricardian Ambivalence on RBA decision-making

The thoughtful and very experienced RA echoes my thinking on this subject, and I think his logic is hard to fault. But applying unconditional logic to RBA decision-making is not always a productive exercise. The better aspiration is to work out what a room full of the different stakeholders on the RBA Board are likely to resolve. I am also similarly minded in terms of triggers for a February cut, especially sub-0.5% core assuming no substantial upward revisions to past data, which I would emphasise again is something to look out for given the ABS is now re-estimating the seasonal factors every quarter. Here is what RA says:

After describing both the November and December rate cuts as close calls, it is clear that the RBA would like to wait and see how things unfold.

The question is if they have the room to do so?

Recent global data has firmed up somewhat, and the muted response to European downgrades suggests that the downside risks might not be as large as feared – so it seems a better than even chance they will hold at 4.25% in February.

There are two reasons that waiting to see is good policy.

First, the cuts were (in a sense) pre emptive, so it is wise to take time to assess the forecast that motivated those cuts. All forecasts are uncertain, as are the transmission mechanisms from lower European growth to the RBA’s Aussie inflation forecast, but it is seldom that central banks have the luxury of taking time. The recent improvement in data and markets gives them time, so they should take it.

Second, waiting will give them information on the impact of the 50bps of cuts so far. We have data until November now, and the bulk of it suggests modestly sub trend growth in H2’11. This means that the unemployment rate might only have been expected to drift up slowly if they had not eased. With policy now a little easier, it is possible that things are now balanced.

What might get the RBA to cut in Feb?

Well, if the unemployment rate goes up again (out Thursday 19 Jan), core CPI is sub 0.5%q/q again (out Wednesday 25 Jan), or markets start melting down in a delayed reaction to the European downgrades (or some other shock) the RBA is likely to ease.