Why the Reserve Bank of Australia should limit tomorrow’s rates hike to 0.25 percentage points

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Got a hot tip for tomorrow? Do you go for the favourite or the outside chance?

Flemington will come alive at 3pm AEDT when the steeds in race 7 hit the track to determine this year’s Melbourne Cup winner.

But the big day traditionally features another major event that attracts far more punters and a whole lot more cash. This year promises to be even bigger than usual.

Half an hour earlier, Reserve Bank governor Phil Lowe is set to deliver a decision on interest rates, with billions of dollars riding on the outcome.

Why Melbourne Cup day? Well, the RBA meets on the first Tuesday of every month, bar January, and until now, there have been just four of those months that immediately are preceded by an inflation result. November is one of them and it just so happens the Melbourne Cup is always run on the first Tuesday of that month.

a man at a podium
RBA governer Philip Lowe has previously said he’s committed to preventing the “scourge” of high inflation. (ABC NEWS: John Gunn)

Last Wednesday, the September quarter inflation numbers dropped, and when they hit the trading screens, financial markets went into overdrive.

After the fastest rate hikes in history — 2.5 percentage points since May — there were hopes the pace of price growth might have slowed. But it wasn’t to be. The numbers were much higher than anticipated no matter which way you looked at them.

Even the RBA’s preferred measure, which strips out a lot of one-off movements and volatile items, set a cracking pace.

As a result, the biggest bet in town right now is a toss-up between whether the RBA will return to its double rate hikes of last month or maintain the single 0.25 percentage points lift that it dialled down to earlier this month.

The problem with economists

For the past 50 years, the world has increasingly been run by economists. They infect, sorry affect, government and the decision-making process of almost everything from health to air safety and, most importantly, how to keep the economy on an even keel.

If that’s the case, why do they so often get it so wrong? Just think of the number of financial market crises and economic meltdowns we’ve had since the 1980s, including the global financial crisis of 2008, which originated in of, all places, the United States — the place where the economics profession rules.

The kerfuffle about tomorrow is an illuminating insight as to how things can go so askew.

RBA building
Economics is far from an exact science. (AAP: Joel Carrett)

Economics is an inexact science because it is a study of human behaviour. As we all know, human beings can be entirely unpredictable. That’s when they’re acting as individuals. Put millions of them together and just about anything that can go wrong, will.

The economics profession assumes that’s not the case, that everyone always acts rationally. So, we’re already off to a bad start when it comes to forecasting.

Many then reduce everything to mathematical models that plug in data about how we’re performing and what to do next. And that’s where things really get messed up. Depending on how the input data is collated and the number of ways it can be interpreted, the end result is every bit as reliable as a dartboard.

Inflation acceleration

Last week’s inflation data came in much hotter than expected. Immediately, financial markets pushed borrowing rates higher on speculation of an official double hike tomorrow. A range of market economists joined the throng.

They’ve plugged in last week’s 7.3 per cent annual headline inflation along with the monthly jump and what’s known as the core inflation and, bingo, decided the RBA will have to move by 0.5 percentage points.

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