Doves and hawks equally balanced at the RBA

Even though the board of the Reserve Bank will decide to leave official interest rates on hold at its meeting today, it does not mean that the debate around the board table will be dull.

The hawks on the bank's board – that is, those thinking that the next move in interest rates should be up – will cite better news from the global economy, rising house prices, a surge in stock prices, robust consumer sentiment and a still favourable outlook for business investment as the key signs that the economy is poised to lift through 2013.

The doves, or those thinking that a further interest rate cut or two might still be necessary in the months ahead will again point to the 28-year high for the Australian dollar, soggy business confidence, what looks to be on-going very low inflation and the declining terms of trade as reasons why a bias to cut interest rates should remain firmly in place.

It is this contrast in views which means interest rates will not be moved.

The context for the difference of opinion is the fact that monetary policy is already accommodative. The cash rate is 3.0 per cent, having been cut 175 basis points since November 2011. This means that any more interest rate cuts from here will make monetary policy very easy. Maybe policy will be too easy with the cash rate at 2.75 per cent given the signs of upside momentum in the economy that are coming through.

While the Reserve Bank never has and never will target house prices, it is probably getting a little antsy about the fact that house prices rose by 2.7 per cent in the March quarter. In itself, this is not a worry given this rise is starting to reverse the fall in house prices that occurred over the course of 2011 and 2012. Having witnessed the consequences for banks and the macroeconomy from a house bubble bursting in the US, UK, Japan, Spain and elsewhere, the Reserve Bank did not and would not ever want to see sharp house price falls in Australia. This is one reason why it embarked on an aggressive easing cycle. That said, the RBA would not want to see a house price bubble emerging through monetary policy being too easy as that would present a longer term risk to the economy.

The recent house price upswing is a big reason why the doves looking for an interest rate cut need broad economic weakness for that projection to come to fruition.

Over the next couple of months, there will be some vital economic information on the economy that will determine whether the hawks or the doves win the day.

The next labour force data are released next week on 11 April and this will be a test of the robustness of the 71,500 shock employment lift last month. It is likely that employment will fall by between 40,000 and 50,000 as a correction from that outsized statistical gain.

In addition to the jobs data, the March quarter inflation data are released on 24 April and they should reinforce the news of the last three years that show inflation is still low and stable, anchored in the middle to lower half of the Reserve Bank’s 2 to 3 per cent target range.

The federal budget on 14 May also looms as a potential influence on monetary policy. If the government ‘neutralises’ the extra money that will be inevitably spent on the National Disability Insurance Scheme and education reforms through offsetting spending cuts, the Reserve Bank can rest easy that fiscal policy is broadly neutral and not adding to, or subtracting from, the overall pace of economic growth. If, however, there are not the cuts and other savings to offset the spending on new programs, fiscal policy will be a little stimulatory and would therefore work against further rate cuts and give support to the hawks wanting to lift interest rates in the months ahead.

In addition to these domestic influences, of course global conditions will be critical to the bank's deliberations. Just how strong is the US recovery? Will the disconcerting news that flows from Europe, almost on a daily basis, translate to weaker economic conditions? Is India past its low point and will Abe-nomics in Japan kick start growth and inflation? What of the 8 per cent plus GDP growth expectations for China? Is that sort of growth likely or is the Chinese property bubble bursting going to derail the recovery?

What of commodity prices? Iron ore has been extremely volatile while the broad global commodity price indexes have been broadly flat for the best part of a year.

All questions that are vitally important for determining the interest rate outlook.

Until there are answers to some of these questions, the safest bet is for official interest rates to remain on hold. They may even be on hold all the way through the remainder of 2013 as the Reserve Bank sets policy to support growth, but not too much.