The RBA has egg on its face and needs to cut rates by 50 basis points: Alan Kohler

The Reserve Bank's economics department had a bad year in 2011, and as a result the board is now high and dry with an official cash rate that is obviously wrong. It needs to come down by 0.5%, to 3.75%. 

In its February 2011 Statement on Monetary Policy, the RBA had a GDP growth forecast for the year ended December 2011 of 4.25% and for June 2012 of 3.75%. CPI inflation for June 2012 was forecast at 2.75%, the same as underlying inflation.

But then in May the bank's economists came over all bullish and upped their GDP forecast for June 2012 to 4.25%, while leaving the December forecast at 4.25%. CPI inflation for June was cut to 2.5%. In August the GDP forecast was up again to 4.5% and while the CPI forecast was left at 2.5%, the underlying inflation forecast was jacked up to 3%.

In November wobbles started to appear and the GDP forecast was cut to 4% and underlying inflation back to 2.5%. In February this year the GDP forecast for June 2012 was back to 3.5% but underlying inflation was actually raised to 2.75%.

So the RBA's economists have made two big mistakes: they got 2011 GDP growth horribly wrong and raised their inflation forecast in February for this financial year even as GDP was falling short.

It's hard to know what came over them on GDP in May last year, but the statement was especially bullish about commodity prices and resource and farm exports. Maybe they were influenced by Treasury, which had a GDP forecast for 2011-12 of 4% in the May budget last year, which has also turned out to be wildly wrong, leading to a bigger than expected deficit (by almost $10 billion).

But why the RBA felt the need to be more bullish about economic growth than Treasury in the middle of last year will probably have to remain a mystery, but that rush of blood to the head in May is still dogging the Reserve bank governor, Glenn Stevens and his board.

With GDP growth of 3.5% and underlying inflation of 2.75% in their February SMP forecasts for 2012, the board could hardly cut rates then, no matter how hard the business people on the board were arguing for it.

The minutes for the April meeting drily say: "Members noted that the national accounts for the December quarter had shown an increase in real GDP of 0.4% in the quarter and 2.3% over the year, which were both lower than expected."

Well, yes, that's an understatement – as recently as November the economists were forecasting 2.75% growth for 2011; just six months earlier they'd been forecasting 4.25%! That's almost twice reality.

One can imagine a fierce debate in the April meeting between the business people and the economists, with the latter clinging to the last shreds of their dignity. In the event they persuaded the board to wait for the March quarter inflation figure before cutting rates and hanging them out to dry.

Kerplunk! March quarter CPI inflation was 1.6%, against last November's forecast for the year to June of 3.25% (there wasn't a forecast for the March quarter). By February that had been slashed to 1.75%, but even that now looks too high.

Next Tuesday it will be, or should be at least, a bedraggled, hangdog group of economists who shuffle into the RBA board meeting for their presentation. And many of the board members may well be checking their emails while it's going on, having already made up their minds to cut rates by 50 basis points.

Which is what they should do.

This article originally appeared on Business Spectator.