Two giant global forces look like they're shifting ahead of the RBA's critical May meeting

The RBA Board meets on May 5th to decide whether or not to ease monetary policy from the current modern-day low of 2.25% to a new low of 2%. But what seemed a universally agreed position that we’d see a rate cut in May just a few short weeks ago has now become a much more nuanced call.

Last week the NAB was the first major forecaster to say that they believed the RBA would hold rates steady in May. Paul Bloxham, HSBC Australia’s chief economist said that the iron ore rally could stop the RBA from easing in May while the ANZ said it’s a “line ball call.” Over at Westpac chief economist Bill Evans, who was the first major forecaster to predict the February rate cut still believes that, “the case for a cut in May remains strong and we continue to expect the Bank to finally deliver on the second leg of the 50bps of cuts in ‘early 2015’ we forecast back on December 4 last year.”

But as the key forecasters in the nation grapple with what the RBA will do next week it’s apparent that the global economic and market backdrop is shifting, also complicating the decision for the RBA.

On the one hand the apparent bottoming in the price of oil has fundamentally changed the landscape for inflation.

Whereas the big crash in oil in Q1 saw headline inflation around the world fall heavily so the recovery in prices – which in Nymex Crude terms are up around 30% from the lows means that for the first time in ages, inflation expectations are moving higher.

That’s important, because even though last week’s Q1 CPI inflation showed an incredibly benign 0.2% the core inflation number – which strips out volatile items – was 0.6% for the quarter and 2.35% for the year. That’s still comfortably within the RBA’s 2-3% band. So you could argue that crude has little impact on the number that the RBA and other central banks around the world focus on.

But headline inflation drives expectations for both consumers and the market. So, as crude rallies away from the low and as inflation expectations around the globe change, so the move toward higher rates around the globe – especially in the UK and US – comes closer.

That’s actually good news for Australian growth because associated with the rise in crude is a generalised change in sentiment toward commodities in general. That means that iron ore looks like it might have bottomed as well, and while coking coal is yet to sustainably head higher, thermal coal out of Newcastle has rallied. Which means both national income and the government’s coffers are looking better, if only by a small margin.

So the RBA may be about to announce an upward adjustment to growth in the Statement on Monetary Policy to be released on May 8 – 3 days after the May board meeting. At worst the outlook appears to suggest that any deterioration will have ceased.

That doesn’t mean that Australia will magically see growth lift back to, or above trend, but the need for another rate cut is a closer call than it was.

Normally anything that suggests that the Fed is more likely than not going to tighten rates would automatically be good for the US dollar. That makes this week’s Q1 GDP released and FOMC meeting on Thursday night all the more important.

But Citibank foreign exchange analysts believe that while the US dollar rally isn’t over it is certainly “mature”. That’s taking the pressure off the Euro, Sterling, Canadian and Aussie dollars which are all grinding higher.

Which means that when the RBA Board meets on Tuesday May 5th it will be faced with an improved domestic economic landscape, a better outlook on the commodity front, the probability the budget won’t be as dire as it could have been just a month ago, and an Aussie dollar which even though biased higher is still below 80 cents.

It’s the nature of central banking in 2015, however, to use one instrument – monetary policy – to deal with the ever shifting sands of the global economy and markets.

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