There was no direct pointer to the likely path of interest rates in the quarterly monetary policy statement, however it was based on an economic outlook that implied rates would probably fall a bit and possibly by a lot.
The statement, released by the Reserve Bank of Australia (RBA) on Friday, included forecasts that the underlying rate of inflation, aside from big one-off price moves and allowing for the carbon tax, will be steady for the coming year or so.
From just below the mid-point of the RBA’s two to three per cent target range over the year to September, underlying ex-carbon inflation is projected by the RBA to stay at the mid-point until the second half of 2013.
Even then, it is tipped to rise only into the upper half of the band rather than edge through the top, as the RBA had forecast in its previous quarterly statement.
Meanwhile, the economy’s failure to live up to the RBA’s previous forecasts for economic growth means unemployment is forecast “to rise a little, before declining gradually as the economy gains momentum later in the forecast period”.
That is the central forecasts scenario, which would appear to preclude the possibility of an interest rate rise, at least over the coming year against an expected background of rising unemployment.
There may be some downside possibilities for rates if this central scenario pans out as expected, but probably not much.
Given the lags involved, cutting rates now would mean stimulating the economy through that period when it is already assumed to be picking up to growth rates around the long-run average of about 3.3 per cent.
It is unlikely that the RBA would want to push the economy much faster than its long-run average pace for very long, with the level of unemployment hovering near historic lows.
Even so, another rate cut is easily possibly in the next few months to ensure unemployment does not rise more than “a little”.
But the central scenario has some big risks around it, Europe in particular.
“The central scenario assumes the European authorities do enough to avert extreme financial dislocation, but are unable to avoid periodic bouts of considerable volatility and uncertainty,” the RBA said in the statement.
But the RBA is well aware of the risks.
“A materialisation of the downside risks would likely be very disruptive for Europe and could result in a deep recession,” the RBA said.
On the upside as far as inflation is concerned, there is a possibility of a “general improvement in global confidence”.
As well, the spillover effects from the mining sector could turn out to be stronger than in previous booms, rather than weaker, as is currently expected by the RBA.
But the central bank noted these upside inflation risks for Australia only briefly in the statement, dwelling at length on the gloomier side of the probability distribution.
“The possibility of a significant global downturn is the main downside risk for inflation,” the RBA said.
Such an outcome – or even a significantly heightened risk of it – is anything but a trivial risk.
Accordingly, the chance of a precautionary series of interest rate cuts – such as the run of cuts taking cash (currently 4.5 per cent after the cut this week) to below four per cent, as envisaged by Westpac’s chief economist, Bill Evans – is equally non-trivial.
