Time to punt on a rate cut for Melbourne Cup day?

It’s what all investors want to hear – the latest inflation figures leaves the path clear for an immediate rate cut, according to the Housing Industry Association (HIA). If that’s the case, rates would drop next Tuesday, just in time for Melbourne Cup day. 

Senior economist Andrew Harvey says the consumer price index for the September 2011 quarter confirms the Reserve Bank of Australia (RBA) has been judging monetary policy on the basis of overstated inflation figures.

“Revised consumer price index methodology by the Australian Bureau of Statistics means that in effect, the RBA has been recently targeting an inflation rate of 1.75 to 2.75 per cent, rather than its stated rate of two to three per cent. This raises fresh questions over the RBA’s retention of a tightening bias over much of 2011, but more importantly it leaves the RBA with plenty of space to cut rates by the end of this year,”

Harvey says. “The change of recent estimates of underlying inflation is not an inconsequential issue – what’s arguably the most important macroeconomic tool in the economy, monetary policy, has been managed on the basis of data that’s well short of the mark. It adds weight to the industry’s long-held view that interest rates were taken too high.”
Commsec’s economist Savanth Sebastian shares a similar opinion, reporting the annual rate of inflation has fallen from 3.6 per cent to 3.5 per cent.“The RBA can certainly rest easy on the inflation front,” Sebastian says.However, punting on a rate cut on Melbourne Cup day doesn’t mean a guaranteed win just yet, he warns.“It’s always important to remember that the RBA sets interest rates by looking forward, not backwards.

While inflation is now comfortable, in recent times policy officials have highlighted that financial conditions have already eased somewhat since the start of the year, with the slide in market interest rates and the Aussie dollar providing a marginal degree of stimulus. So it’s by no means assured that the RBA will definitely cut rates next week.

“What is clear is that domestic inflation will not stand in the way of a rate cut, however the focus now shifts to Europe. If the European summit is unable to provide a definitive solution to the sovereign debt crisis, then it’s looking likely the RBA will move to shore up confidence and provide stimulus by cutting rates by 25 basis points on Melbourne Cup day.

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