Following the release of benign inflation data last Tuesday, the conversation in Australia has moved on from whether the RBA will cut rates to a case of how often and by how much. Next week sees the RBA meet with expectations of a 25bps cut followed by another 25bps in June.

This is a crucial deliberation by the RBA on a number of fronts. The current cash rate of 4.25% does give the RBA room to move but in the current uncertain environment, each basis point is precious. It is important that cuts aren’t made needlessly or ineffectively. With confidence low but employment strong, the dilemma for the RBA is how to earn the best bang for its buck with the next series of cuts. And how much should be kept away for a rainy day?

The most recent experience highlights the dilemma. The RBA’s previous two cuts, 25bps in each of November and December last year have been completely ineffective, with consumer and corporate confidence, and credit and financing growth now even lower. The problem was a failure to “shock and awe”, with their impact on confidence diluted by a failure of the banks to pass on the entire amount, a continued lack of political leadership, and rising cost of living pressures. The federal government is also committed to a surplus next fiscal year, thereby withdrawing stimulus from the economy at a critical time.

So what should the RBA do? A 50bps cut next week would make a very strong statement. Confidence is all important. A cut of this magnitude, coupled with additional tax cuts of $300-800 per taxpayer from July 1, and carbon tax compensation payments of $300 to low income households also in May, would see a real stimulus to activity levels. The dollar would be lower too and we would expect to see the consumer, retail and manufacturing sectors enjoy some significant relief from what has been challenging times.

The RBA remains inherently conservative however, and 50bps may be too many steps too soon. We shall see!