Just  one  week  out  from  the  RBA’s  next monetary policy announcement, financial  markets are pretty much 50:50 in their assessment of whether the cash rate will be raised by another 25 basis points, to 6.5% pa. at 9.30 am Sydney  time  on  Wednesday  the 4th of April, following the previous day’s Board meeting.

So  how  did  it  all  come  to  this,  when as recently as two days before Australia  Day  an  unequivocally  benign  December quarter CPI triggered a sharp  (17  basis point) drop in implied yields on the most actively traded (and  it  was  very  active)  90-day bank bill futures contract? And then a further  drop  of  around  10 basis points in the wake of the late February stumble on global equity markets.

Enter  into  the  fray  the  RBA’s Assistant Governor (Economic) Dr Malcolm Edey’s  warning  on 16 March that markets had firstly jumped on the ‘sky is about  to fall in on the global economy’ bandwagon too readily, followed by a  few  clinchers  like … “inflation is more likely to be too high than too low  in  the  period  we  can  foresee”  and … “Information that has become available  since  that  forecast was made suggests that some of the factors pushing up underlying inflation last year remain in place”.

Does  all  of  this  mean that the RBA is more likely than not to raise the cash  rate  again  this  year?  (yes,  pretty  much,  but  the  balance  of probabilities  in  favour  is not overwhelming, by any means) and if so, is the  hike likely to happen sooner rather than later? This is the part where fence sitting has become an art form in itself in the last few days.

Above  all, monetary policy is all about the RBA’s judgement of the balance of  risks  to  its  key forecasts, in this case on the one hand the risk of inflation  being  allowed to get up too much of a head of steam, versus the risk  of another local cash rate increase being implemented just as the sky really does fall in on the global economy.

And what is the risk that the global economy gets derailed at high speed by the  crystallisation  of  one  or  more of the many risks that overhang its operation,  in  which case upside inflation risks would be the least of the RBA’s worries?

The  tentative  track  back up in major equity price indices has stalled in the last day or two - the Dow has fallen two nights in a row, while the All Ords has, not surprisingly, taken Wall Street’s lead. But both are not much shy of their recent historical peaks.

So unless a significant shock occurs in coming weeks and months, the global economic  backdrop  remains  conducive  to  further  consolidation  of  the Australian  economy  - and consequently does not stand in the way of a cash rate increase if the RBA is so inclined, and it seems that it is.

The  foreign  exchange  market  seems to be latching onto the sooner rather than later line with gusto, as evidenced by the rapid run-up in recent days (although  it  has  stopped to draw breath today) in the Australian dollar, not  just  against a still soft US dollar, but pretty much across the board (the also mulit-year high NZ dollar being a notable exception).

How  much  of the local currency’s strength would evaporate if the RBA does not  move  next week? A fair chunk of it, you would think, because widening short-term  interest  rate differentials between Australia and the US are a key reason for the aussie’s ascent.

Does the Australian dollar’s rise have the capacity to obviate the need for another  cash  rate increase? Theoretically, yes, because a rising currency does  some  of  the  RBA’s work for it - both by making Australia’s exports less  competitive  on  global markets - not that that is an aim of monetary policy  -  but  also  by  taking  some of the sting out of inflation as the prices  of  imported  goods (including oil, of course) fall (or at least do rise  as quickly). But these things take time to flow through, and it seems that  the RBA does not have that kind of patience just now when it comes to locking in low and stable inflation.

As  recently as 2001 - hardly ancient history - the RBA was easing monetary policy  even though underlying inflation was rising to what we now know was a  cyclical peak of 3¼ per cent (December of that year). But the statements issued  by  the  RBA  announcing  each  of  the  easings were littered with references  to  how  much spare capacity the Australian economy had to play with  at  the time. Conversely, recent statements are just as peppered with references  to  how  close  that  same Australian economy is to a string of capacity constraints.

Moreover,  China was a sleeping giant six years ago that is very much awake now.  And the RBA seems to think China is enough of an external stimulus to Australia’s  economy  to  offset apparently looming softness in the world’s largest  economy  as  the  fallout  from  the so-called ‘sub-prime’ housing market meltdown percolates through the broader US economy.

But  even  on that one the RBA hardly seems to be overly concerned … “There has  also  been  some  well-publicised distress in the ‘sub-prime’ mortgage market in recent weeks. How far these things might dampen activity is still unclear,  and recent indicators have been ambiguous. But at this stage, the overall  slowing  in  the US has been mild, and the housing downturn so far has not caused any major disruption to output and employment in the rest of the economy”. Dr Edey on 16 March again.'