Hold your horses: RBA rate cut no sure bet

The Reserve Bank might well serve up a surprise for markets and leave interest rates unchanged today.

The Reserve Bank might well serve up a surprise for markets and leave interest rates unchanged at its policy meeting today.

Surveys of economists show there is a high level of confidence in an interest-rate cut at the RBA’s monthly meeting, with markets pricing in a two-thirds probability the cash rate will be lowered from 1.75 per cent to a new record low of 1.5 per cent.

But scratch a little under the surface, apply a little heat, and that confidence exhibited among economists fades rapidly. Many have been fumbling wrecks in the week leading up to the policy meeting, quietly admitting the outcome might easily result in an on-hold verdict.

Heavily invested in their market forecasts, which are shopped around to clients paying high fees for the wisdom, it can sometimes take a lot for economists to quickly change view, especially on the topic of interest rates.

Their trade is cautious opinion making, thrashed out over time in often heated in-house meetings. Skittishness is discouraged. It’s not a good look.

For that reason, many economists were deeply disappointed that second-quarter inflation data, published last week, did not contain an unambiguous “go” signal to further lower interest rates. Instead, the data was somewhere in the middle, unclear, the stuff of nightmares. In that uncertain environment, most have chosen to hold the line, even if every atom in their bodies is plump with doubt.

For its part, the RBA would have looked at the CPI data last week and concluded the numbers were unsurprising, even pleasantly in line with forecasts mapped out in May.

There was even evidence in the report of a broadbased bounce in domestic inflation, which tends to give a reliable signal on underlying price trends.

Critically, there was little if anything in the CPI data that would suggests the RBA will revise lower its inflation forecasts this Friday when it publishes its quarterly Statement on Monetary Policy.

Apply some heat to those already sweaty economists and some admit that if the RBA does change its forecasts, it is more likely to nudge up in its expectations for GDP growth.

To be sure, in minutes of its July policy meeting published two weeks ago, the RBA opened the door to an interest-rate cut this month, saying it would assess the second-quarter inflation data to gauge the need for a change in rates. But having now done that over the last week, it might well have come away cold.

Steady inflation and higher growth forecasts do not form a narrative to support cutting interest rates.

For a central bank that values its communication with markets, it might feel odd to cut today, and then revise growth forecasts higher on Friday.

Like most of the world’s major economies, Australia has a problem with low inflation. Current forecasts don’t have on-year inflation rates rising back into the RBA’s desired 2-3 per cent target until mid-2018.

But even that slowly rising flight path won’t make the RBA feel as if inflation has lost contact with the target band.

There is flexibility around the target, and the RBA is making full use of it.

There is scope for the RBA to sit on its hands until November. Currently it can’t be sure that the unusually benign first-quarter inflation data gave a reliable signal.

There is precedent for the CPI giving bad signals. A decade ago the RBA was slow to tighten interest rates after successive quarters of low readings on core inflation. The inflation genie very nearly escaped its bottle then and fled.

The RBA has scope to leave interest rates unchanged this month if it wants, more scope than economists and market bets are suggesting.