No, the RBA has not lost the plot

Photo by Dan Kitwood/Getty Images

The RBA blindsided quite a few people recently with this month’s rate cut, to a modern day low of 1.75%.

They then blindsided almost the entire trading and forecasting community with an aggressively downgraded outlook for inflation and what the market believes it implies about the future path of interest rates. Banks are falling over themselves to downgrade their cash rate and Aussie dollar forecasts as a result.

The RBA forecasts seem to imply a modern day paradox of lower inflation, but with relatively strong growth. That’s confounded some and infuriated many who think the RBA risks reigniting a housing bubble.

But does the fact that the RBA caught traders, investors, and pundits by surprise, or that they hold a different view to the one that prevailed in the orthodox trading and investment community prior to their announced changes mean they have lost the plot, or are mad?

Obviously not.

Could they reignite a housing bubble?

Obviously yes. But the nation’s central bank also made it clear they believe APRA has their back on that front.

Infallibility

Central banks, like traders and investors, must make decisions now about the future in uncertainty, hoping they did the right thing, pulled the right lever, and made the right choice.

That decision is made today and it efficacy and impact is judged in the future.

Central banks, like traders, evaluate their options given the uncertainty around their judgement and the future and then act accordingly.

No central bank is, or claims to be, infallible. Certainly to my knowledge the RBA has never made such a claim.

Over my career there is little argument that the RBA’s made mistakes on forecasting, the exchange rate, and more recently the reaction function of Australian housing investors to the lowest interest rates on record.

Equally, since 2003, they have presided over a house price bubble, two mining booms, an AUD/USD that ranged from 0.4775 to 1.1080, and more recently the extreme reaction of housing investors in Sydney and Melbourne to low rates.

Through these years, and most of the 10 before then, the Australian economy has escaped recession.

Do least harm

It strikes me that that in their actions and words the RBA has been guided by the principles enshrined in the Act stencilled onto the wall in the foyer of the RBA’s Martin Place headquarters.

RBA duty under its Act of 1959 (Picture: Greg McKenna)

The RBA takes its duty to act “in the greatest advantage of the people of Australia” seriously. If I was to paraphrase what they do, I’d say the mantra is “do least harm”.

It is in this light that we should be judging their current signals.

Sure bank after bank is now falling over themselves to say rates will fall to 1.5%, 1.25%, or 1% with a chance they’ll go lower. But this move, for the most part, and with very few exceptions, is based on guesstimates by forecasters of the RBA’s reaction function to its new inflation and growth forecasts.

These forecasters, and most of the market, are – like the RBA – reacting to new stimuli in the form of the central bank’s forecasts rather than their own independent analysis of the situation. Independent analysis that failed to come up with substantially lower rates until prompted by the RBA.

So they are no different to the players in the famous Keynes beauty parade analogy.

It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.

These new forecasts of 1%, 1.25%, and so on could have been made before the RBA signalled that inflation was indeed going to be lower in the future.

But they were not.

Like a child who has discovered that there really is something under the bed, or in the closet, the market is now jumping at shadows. No doubt while the RBA marvels at their newfound commitment to the cause of lower rates and a lower dollar in Australia.

Am I being too harsh on these forecasters?

Of course I am.

They are doing their best to get some clarity around what the RBA will do and how it will impact the economy, interest rates and the Australian dollar.

There is nothing wrong with that. But to those who say the RBA is wrong, is mad, or has lost the plot all I’d say is time will tell and the RBA will adjust to changed circumstances

So far, what we know is Glenn Stevens and his board have just engineered one of the better episodes of jawboning the Australian dollar lower.

As to the rest, only time will tell.

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