Lots of mea culpas this morning from business economists and media pundits who got the Reserve Bank rate decision horribly wrong yesterday. A couple were close: Paul Bloxham, of HSBC (and a recent RBA departer), said it was a lineball decision, and David Bassanese wrote in The Australian Financial Review about 10 days ago that it was close and a no rate cut decision wouldn’t surprise.

Many of the same people who got it wrong are blithely telling clients and readers this morning why yesterday’s decision made sense.

They are also saying that the central bank has left the way open for a rate cut, if conditions in the economy worsen, which is true, reading the post-meeting statement yesterday from governor Glenn Stevens.

But that belief ignores another possibility: that the RBA could increase rates, if there’s a sharp rise in inflation (as we saw early in 2011). They don’t see that possibility but the key part of yesterday’s statement, allows the RBA the flexibility for such a move:

“With growth expected to be close to trend and inflation close to target, the board judged that the setting of monetary policy was appropriate for the moment. Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy. The board will continue to monitor information on economic and financial conditions and adjust the cash rate as necessary to foster sustainable growth and low inflation.”

It’s the use of the phrase “appropriate for the moment” that rules out any more rate cuts for now. That is unambiguous: the economy is close to “trend”, so no more cuts. This directly contradicts the line we’ve been getting from the doomsayers, particularly retailers and the “white-collar recession” spruikers.

If growth starts slowing, or unemployment rises, the RBA can cut rates to try and bring growth back up to trend, where it is now. If Europe hits the wall (a prospect that is less of a threat now, as the RBA acknowledged yesterday), it can also cut rates. And rates will rise if the RBA sees a looming rise in inflationary pressures in future months.

The RBA sees inflation easing in the next two quarters simply because of the slowdown in fruit and vegetable prices (those bananas): “CPI inflation has declined as expected, as the large rises in food prices resulting from the floods a year ago have been unwinding. Year-ended CPI inflation will fall further over the next quarter or two.”

That could see the much-vaunted inflationary impact of the carbon tax ending up less than forecast, simply because the underlying rate had slowed.

And now it’s up to those big brave banks, especially the ANZ, and then Westpac, to justify their rhetoric about their cost of funding. Don’t you like how the RBA has hung the Big Four out to dry, removing the cover of a rate cut? Now the sainted Gail Kelly and Mike Smith, the two moaners in chief, have to justify their multimillion dollar salary packages and bonuses by either biting the bullet and lifting rates, sending customers, the media and politicians into a blind fury, or leaving them where they are and cutting costs (jobs).

The RBA also acknowledged that the strength of the Aussie dollar since late last year has been a bit surprising:

“The exchange rate has risen further, even though the terms of trade have started to decline. This is largely a reflection of a decline in the euro against all currencies. Nonetheless, the Australian dollar in trade-weighted terms is somewhat higher than the bank had previously assumed.”

We actually saw a good example of that overnight, the euro hit a two-month high against the greenback because the day’s news from Greece wasn’t bad (no agreement yet, but no failure). The Aussie dollar held its gains against the euro, and remained just under $US1.08 to the US dollar. The Aussie dollar made gains against the greenback in December to mid-January when it rose strongly against the euro. The Aussie has hung onto those gains, and those against the euro, despite the latter’s solid rise in the past three weeks.

That will place further downward pressure on inflation, as will oil and petrol prices, if they continue around their present levels, which are not far from where they were in 2011.

The euro’s strength reflects the optimism that the eurozone is slowly pulling out of the near-death experience of late last year, thanks to the European Central Bank’s sale of €489 billion of three-year loans to European banks. Another auction of three-year loans happens on February 28, which will pump more liquidity into the system for March, when the second Greece bailout had to be tied up (the deadline is March 20 when a €14.5 billion loan matures). Greece can only repay that with money advanced from the huge second bailout package.

If that doesn’t happen, default looms, but the ECB’s efforts to ease liquidity will provide a huge cushion for any problems in Greece might create.

That’s not to rule out matters going badly in Europe and markets freezing up. If that happens, the government can say goodbye to its surplus. But the RBA’s prudence now will ensure it has a lot of room to move quickly to slash rates.

Peter Fray

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