The RBA board braces for a rare level of scrutiny

It will begin or set in train a ­series of interest rate cuts designed to fight deflationary pressures, encourage investment and weaken the Australian dollar.

If the cutting starts tomorrow, it will be controversial too. Until as recently as last week most economists were unsure whether any further rate cuts were even required. A survey of 30 market economists released by finder.com on Thursday showed 28 expected no change tomorrow; 14 expected at least one cut sometime this year, and 16 believed the next move would be up.

“The RBA at its last meeting in December reiterated that a period of stability in interest rates ­remained prudent and since then strong data for jobs and building approvals has offset softness in economic growth and inflation indicators,” said AMP's respected chief economist Shane Oliver, reflecting the general mood.

The economy generated almost 100,000 jobs in the last three months of 2014, while record low mortgage rates have continued to stimulate home buying and building. On top of that the Australian dollar has fallen further since ­December to not too far above the US75c sweet spot senior RBA officials had hoped for. And a further 25 per cent slump in the global oil price since then has boosted household income via cheaper petrol, equivalent to a 50 basis-point interest rate cut.

But these blessings are increasingly being discounted. A day after the keenly awaited December quarter inflation figures appeared to rule out any cut, veteran finance journalist Terry McCrann, who has correctly predicted about 70 per cent of RBA rate moves since the GFC, emphatically argued the RBA would cut the cash rate tomorrow. Debt markets rallied, pushing yields to new historic lows. The implied probability of a rate cut surged from as low as 7 per cent to higher than 60 per cent.

While domestic data might be benign, the global economy is sagging, he said. Both the World Bank and IMF have recently downgraded their global growth forecasts despite the precipitous oil slump. Deflationary pressures are emerging in Europe and the US.

Central banks in Denmark, India, Singapore and Canada have loosened monetary policy and New Zealand has explicitly ditched its hiking bias.

Most of all the European Central Bank has unleashed a €60 billion ($87bn) a month bond-buying program in a desperate attempt to jump-start its beleaguered eurozone economies, which will inevitably put upward pressure on the Australian dollar.

Whatever the relative costs and benefits of deflation, ultimately central banks are meant to hit their inflation targets. In Britain and Europe inflation has fallen to 0.5 per cent and -0.6 per cent, respectively, far below central banks' inflation targets of 2 per cent.

While Australia's underlying inflation rate is about 2.2 per cent, the fall in oil could see it fall below the RBA's target of 2-3 per cent. Central banks are less effective if they lose credibility.

Central banks everywhere are operating in uncharted waters. Not since the beginning of inflation targeting around the 1980s have expectations about the ­future direction of prices been so uncertain. Gold is a useless metal but still extremely expensive -- trading at almost $US1300 an ounce or around three times its value before the GFC -- suggesting enough people still worry about inflation.

On the other hand, more and more analysts see deflation as the real threat, and an inexorable decline in long-term interest rates throughout the developed world. Massive debt overhang, waning productivity, and ageing demographics are undermining attempts to stoke demand.

One thing is certain: Australia's relative small size means it cannot insulate itself from more powerful global economic forces.

This article was first published in The Australian. Reproduced with permission.