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, August 2, 2011

RBA loses credibility with financial markets

After six months of 40% upside misses on core and headline inflation, the RBA today told us that its Board "remains concerned about the medium-term outlook for inflation...and considered whether the recent information warranted further policy tightening." It will very likely reveal inflation forecasts on Friday that are either at the top of, or above, its acceptable 2-3% target range.

Yet after months of conflicting forecasts, statements, and jawboning from the RBA, the financial markets have priced in nearly two full rate cuts (or 40 basis points worth) following today's decision to hold. As a further challenge for the RBA, it has chosen to use 'market pricing' for future interest rates as the basis for its inflation forecasts. It is hard to see how this will continue to be possible given that the inflation forecasts will probably be even more grave than the last iteration, which assumed two future rate hikes (as opposed to rate cuts). In this regard, it is possible the RBA will dump its market pricing assumption and opt for something else.

The chart below suggests that the RBA has lost some control over interest rate expectations. As Ricardian Ambivalence correctly notes, the financial markets look to no longer either believe the RBA's inflation outlook, or that it will respond to that outlook. This is a worrying new development.