The RBA's rates policy can't hold for much longer

There is little chance that we'll see the Reserve Bank move at today's meeting -- neither markets nor market economists (according to a Bloomberg survey) expect any change.

If that's the case, the cash rate will have been steady for 16 consecutive months -- the longest period of stability since 2004-06, when policy was changed only once in about two years.

The increasingly difficult question for market watchers is where the RBA will take rates in 2015 -- if anywhere. On 30-day futures pricing, there is an approximately 50 per cent probability of a 25 basis point rate cut by mid-2015. That rises to about 60 per cent by year-end. Economists by contrast, look for a 25bp rate hike by the end of next year. The only agreement is that prior to any move, the RBA will be on hold for a lengthy period.

Recent market moves, especially in the commodity space, may alter that view however. Indeed, it's likely that the odds of a near-term change have shortened considerably. What's difficult to predict is whether that move will be a cut or a hike.

The problem in taking a directional view is that the economy is being hit by several conflicting signals and there is little agreement as to the implications of those signals -- iron ore, in particular. Iron ore has slumped by $A67 over the last year and the terms of trade itself is over 5 per cent lower for the year -- down 22 per cent from the 2011 peaks. According to the popular narrative, that drop has fairly dire consequences for national income and jobs -- not to forget the budget. Some high-profile economists even warn of a downturn or recession. On that view, the drop in inflation that's likely to follow the commodity rout is only going to intensify calls for a cut.

At the same time though, there is still no evidence that any of these concerns are valid or that the overarching policy story -- of weak growth -- is the correct one. On recent indicators, the economy has seen a solid lift in consumer spending. Similarly, non-mining business investment is on the up and credit growth has nearly doubled over recent years. Economic growth numbers, due to be released on Wednesday, are expected to show the economy still growing at around trend -- and that's despite the slump in the terms of trade.

Of course, the other issue to consider is that falling commodity prices aren't a bad thing. While Australians are hardwired to think they are, the sharp decline in crude prices -- 40 per cent over the last year -- is clearly a significant stimulus to the global and domestic economies. Some estimates suggest this could add a full percentage point or more to global growth -- which is already growing around trend.

More broadly, the rise in domestic credit and the surge in house prices has prompted warnings from the OECD that rates need to rise. Indeed, on simple policy rules like the Taylor rule, the cash rate should be between 4-5 per cent -- not 2.5 per cent. There is obviously no risk that rates will return to that level anytime soon, but it does highlight how out of whack policy is at the moment.

By early next year, markets and policymakers should have a better sense as to how things are playing out. We'll see it in the equity market first up -- if the pull-back morphs into a full-blown correction. If it does, consumers will be spooked, which will show up rapidly in the confidence and retail spending figures. Similarly, we'll have a better sense as to whether the recent moderation in house price growth is transitory or not.

Either way, rates on hold is not an option. Things are moving quickly and the economy is either going into a pretty serious downturn -- or conversely a decent upswing. They are outcomes that require a policy response.