The reasons why the RBA won’t shift into neutral

The moment governor Michele Bullock and the RBA board use the “neutral” word, markets will assume a rate cut is impending. Picture: Martin Ollman

There are two important reasons why the Reserve Bank of Australia has yet to totally and undeniably throw out the potential for further interest rate increases and explicitly declare a neutral policy stance.

The first deals with the RBA’s fear that the moment it utters the word neutral in its public missives, financial markets will within seconds lay big bets that interest rates are set to be cut within months.

It is just how money markets work. Like an infantry soldier on the field of battle, traders maintain a 200-yard stare into the future.

The thing they are looking for mostly is changes to how the RBA is acting and what adjectives it is using.

If yields across debt markets fall sharply in line with the RBA’s guidance, it would trigger an unwelcome easing in monetary conditions that could be significant enough to again put a fire under inflation.

The RBA wants to get inflation back into its 2 per cent to 3 per cent target band by the end of next year and an avalanche in money markets would undermine that goal.

With the official cash rate at 4.35 per cent, the RBA likely feels that the overall stance of monetary policy is still on the restrictive side. It doesn’t want the needle to move toward a loose setting.

Despite the big drop in inflation over the last year, it is still too early to start a discussion about when interest rates can be cut.

That is something that will probably begin in the second half of this year. If inflation remains stubbornly elevated, this discussion could be delayed until 2025.

So it is that the RBA says it can’t rule in or rule out anything at the moment.

It isn’t biased toward further interest rate increases, but it also isn’t ruling such a move out.

Neither is it biased toward cuts, but lower rates too must be viewed as a possibility.

That sounds like a neutral bias, but it isn’t just yet.

The second reason why the RBA won’t raise the neutral flag is that its list of reasons to worry about inflation remains long.

The next few months are likely to witness such events as a reasonably big rise in the minimum wage of Australian workers and the delivery of generous income tax cuts mid year.

All of that will coincide with a federal budget that is likely to include new spending measures designed to take the pain out of rising living costs.

Some economists are forecasting that the amount of economic stimulus that is set to come down the pipe will badly frustrate the RBA’s efforts to cool the economy down.

Inflation has retreated, but the final battles to tame rising prices around factors like rents and insurance costs will be the most bloody.

The RBA needs all the help it can get from Canberra at the moment. It doesn’t need another round of stimulus.

Underlying the RBA’s reticence to declare a neutral policy stance is a nagging doubt that it hasn’t yet done enough.

It is a perplexing time for all who watch the RBA. But it is best to just accept the lack of certainty and stay calm.

Things could clear up quickly after the release of the first-quarter inflation numbers at the end of this month.

Then again, uncertainty might rule for a while longer.