You could hear a pin drop as the Reserve Bank of Australia (RBA) failed to deliver a widely expected further cut in rates. Following the announcement, there was a litany of well-founded woe from many affected groups, from the housing sector to retail to manufacturing to the banks. So, what was behind the RBA’s thinking?

The RBA was a reluctant cutter of rates in the first place. However, the deteriorating situation in Europe, and slightly rising unemployment in Australia, was enough to make the RBA cut twice, to 4.25% from 4.75%, as a form of insurance. However, things are somewhat different now.

Over the last 2 months, we have seen some positive developments out of Europe. Of most importance, the move by the ECB to provide 3-year funding to European banks (the LTRO) has been something of a game changer, removing funding risks and freeing up liquidity. This has taken the immediate stress out of the system, and may mean that Europe simply goes through recession rather than a full-blown crisis!

Secondly, data out of China (even with the higher inflation reading yesterday) suggests at this stage that a soft landing is more likely than not. Australian growth is very much tied to China, and there is less concern on this front at the moment.

On the domestic front, the RBA sits far more comfortably with how things are going than most other commentators. Unemployment, after ticking up, has stabilised in recent months. At their current setting, the RBA sees rates as neutral.

Has the RBA got it right? Certainly, the balance of risks is still to the downside. The RBA has kept its powder dry and can move again if things turn down significantly. What is certain is that at a cash rate of 4.25%, the monetary policy flexibility of the RBA is the envy of most central banks around the world.

Marc Whittaker