Why the RBA should have held fire: Bartholomeusz

The Reserve Bank could easily have sat on its hands for a while longer and waited to see how the crisis within the euro zone and the slowing of China’s economy plays out before following up last month’s 50 basis point cut to the cash rate. The fact that it didn’t signals its concern about the conditions both offshore and within the domestic economy.

The 25 basis point cut announced yesterday takes the cash rate back to where it was in November 2009, when the world was emerging from the nadir of the original financial crisis and within a single 25 basis point move of the low point of that cycle in official rates. That provides a useful barometer of the current economic and financial climate.

There were a number of reasons why the RBA shouldn’t have cut.

The new Greek elections on June 17 are likely to be another flashpoint in the euro zone crisis. European leaders are trying desperately to put together a new (some cynics might say ‘first’) ”masterplan” to escape a euro zone implosion. China is trying to rekindle growth.

Within the Australian economy we’ve yet to see the full impact of last month’s 50 basis point reduction in official rates (less what the banks retained), or the impact of the Gillard government’s latest $2.5 billion cash splash or the recent significant decline in the value of the Australian dollar.

There was also, as discussed previously, the issue of preserving as much of the RBA’s diminished capacity to stimulate as it could in case the euro zone does blow up.

There were, therefore, reasons why deferring a move until both the global and local circumstances became a bit clearer might have been a rational decision.

Yet the RBA decided to move, albeit by a modest 25 basis points, which will probably end up being slightly less than that after the banks have trimmed it to offset their increased funding costs. By itself, 25 basis points, or whatever ultimately flows through to households, isn’t going to turnaround the increasingly defensive sentiment of consumers.

That says that the RBA is concerned. It is worried about Europe. It is worried about China. It is worried about the domestic economy. As it should be.

Europe is a basket case and has, as the RBA noted, the potential to generate shocks that would be transmitted through the global financial system and economy. Issues of fiscal sustainability (the euro zone’s fiscal settings can’t be sustained) and its under-capitalised banking system represents a severe threat to global economic and financial stability.