According to Peter Hartcher, markets currently put a 50% probability on the RBA raising rates at its 6 Nov meeting. And not surprisingly, many commentators are predicting that the Coalition’s tax cut package will increase that probability; though the effect of tax cuts starting on 1 July 2008 and backloaded to 2010Â can’t be massive.
But for the RBA, this is a rather tricky recursive problem. The impact of the tax cuts on interest rates should be increasing in the probability that the Coalition will be elected. But that probability will decline if they raise rates. According to the election betting markets, if the RBA does nothing, there’s about a 1/3rd chance that the Coalition will implement its tax package. If the RBA raises rates, there’s less than a 1/3rd chance that the Coalition will implement its tax package. If you were an RBA analyst, how would you handle this one?