February interest rate countdown: Is the RBA weak at the knees?: Christopher Joye

There is something a little asymmetric about the RBA's response to a period of expected high inflation and one characterised by, say, target (i.e., not even low) inflation.

Once the RBA lifted the cash rate to “mildly restrictive” in late 2010, it continued to forecast serious inflation problems right out to 2013. It was quickly confronted with those inflation challenges in both the first and second quarters of 2011. As previously parsed here, it got the yips and decided not to touch its rates lever (having, by its own admission, teetered on the precipice just before the August board meeting).

At the end of 2010, and all through the first half of 2011, the governor of the RBA, Glenn Stevens, told parliamentary inquiries and anyone who would listen that future rate hikes would be few and far between. Words to the effect: expect long pauses between each increment higher. This is what the financial markets were pricing, and he did not want to disavow anyone of it. As it happened, we got no upward movement at all.

We will only really learn in 2012 whether the bank has presided over a second major policy-setting error – the first being the 2006-2008 episode – by getting behind the curve on consumer price pressures.

When the RBA is forecasting, say, trend or slightly less than trend economic growth, and inflation at or near the mid-point of its 2% to 3% target band, it has not hesitated to cut interest rates pre-emptively, not once but twice, into unequivocally stimulatory territory.

After almost every economic metric it referenced when it last met in December has improved, and 2011 core inflation has remained stubbornly in the top half of its target band (not the bottom half as many hoped), a third, consecutive rate cut in February would imply a highly reactionary and pre-emptive effort to ward off slight softness in the Aussie economy. At a time when Australia's unemployment rate remains at a stunningly low 5.2%.

It would suggest to me that the RBA has an asymmetric double standard when responding to inflation. It finds it hard to get rates high enough when inflation rises given community and political resistance to restrictive rates and the extremely dovish complexion of its board, which is dominated by private sector business leaders.

But it finds it awfully easy to cut rates at the first sign of a deceleration in inflation – because, of course, all these vested interests naturally embrace lower rates. Cutting rates is an easy thing to do. The test of a central bank, as the Bundesbank knows, is keeping rates where they ought to be in the face on assorted community pressures.

Glenn Stevens and Phil Lowe: this, my friends, is your legacy to make or break.

Christopher Joye is a leading financial economist and a director of Rismark International and Yellow Brick Road Funds Management. The above article is not investment advice.