Reserve Bank faces a choice between two evils: recession or inflation

The Reserve Bank of Australia (RBA) is once again at a critical juncture, tasked with navigating the treacherous waters between runaway inflation and a crippling recession. Today's interest rate decision is expected to be a close call, mirroring the intense debate that characterized the March meeting.

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If there's any certainty about the Reserve Bank of Australia's interest rate verdict today, it's that it will be a split decision.

Governor Michele Bullock, who likely cast the deciding vote in March, has consistently emphasized the need to curb inflation. However, recent economic indicators present a starkly mixed picture. While headline inflation remains elevated at 4.6 percent, largely due to global fuel costs, the underlying inflation rate has held steady at 3.3 percent. This suggests that while external factors are playing a role, domestic price pressures might be more contained than feared.

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So, it's safe to assume the governor had the deciding vote on an evenly split board.

On the other hand, the impact of previous rate hikes is undeniable. Consumer confidence has plummeted to an all-time low, with business confidence not far behind. This indicates that the RBA's tightening measures are indeed biting into the economy. Furthermore, property prices in Sydney and Melbourne, Australia's largest markets, are showing signs of softening, removing another potential justification for an immediate rate increase.

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Last week's inflation numbers — while better than expected — remain a problem, with the headline number topping out at 4.6 per cent, blown out by the global fuel crisis. But, stripping out fuel and other big swings, underlying inflation was steady at 3.3 per cent.

Unlike past inflationary episodes, such as the oil price shocks of the 1970s, Australia is starting from a higher interest rate base. Coupled with the federal government's likely shift towards fiscal austerity, with tax cuts and spending reductions on the horizon, the RBA may not need to hike rates as aggressively as in previous cycles. The challenge for the RBA is to find a delicate balance, tightening just enough to cool inflation without tipping the economy into a full-blown recession. This balancing act is particularly crucial for an Australian economy heavily reliant on consumer spending and the housing market.

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The March rate hike, meanwhile, has bludgeoned consumer confidence to an all-time low, with business confidence in close pursuit, clearly indicating the previous two hikes are starting to bite.