No need for early 2018 rate change - ANU Shadow RBA

6 February 2018

Australian interest rates should remain at record lows in early 2018 but the economy may need higher interest rates by the middle of the year, The Australian National University (ANU) RBA Shadow Board has found.

The board of the Reserve Bank of Australia (RBA) will hold its first meeting for 2018 on Tuesday to review official interest rates, which have been at a record low of 1.5 per cent since August 2016.

Chair of the RBA Shadow Board Dr Timo Henckel said inflation rose slightly to 1.9 per cent in the last quarter of 2017, the Australian dollar has traded above 80 US cents, but wages growth still remains weak in Australia, pointing to the need for interest rates to remain steady.

"Otherwise favourable economic data, both domestic and overseas, has convinced the RBA Shadow Board that there is no chance a further reduction in interest rates could be called for," Dr Henckel said.

"Instead, it attaches a 63 per cent probability that holding interest rates steady at 1.5 per cent is the appropriate setting, while the confidence in a required rate hike equals 37 per cent.

"Looking to mid-year and the year end, there is a slight shift in the Shadow Board's assessment in favour of higher interest rates."

Dr Henckel said the latest figures still put nominal wages growth at just 2.0 per cent, which remains a problem for the economy.

"The sustained weak real wage growth increasingly becomes a problem as economic growth is not generating additional purchasing power, and thus consumption demand, for a large section of the population. It is also leaves household balance sheets vulnerable in light of their high leverage," he said.

Globally, he said the World Bank has revised its growth forecast for 2018 upward, to 3.1 per cent, while the IMF expects the world economy to grow 3.9 per cent in 2018 and 2019.

"These numbers are bolstered by favourable readings of key global economic data such as investment growth, trade growth, financial conditions, improvements in fiscal sustainability, etc," Dr Henckel said.

"However, there clearly remain downside risks in the form of over-indebtedness, both public and private, and a reduction in the potential growth rate.

"Geopolitical tensions have thankfully subsided, at least for the moment. There remains a real risk of an abrupt correction to inflated asset prices worldwide and the concomitant economic disruptions."

Dr Henckel said the RBA Shadow board attached a 63 per cent probability that holding rates steady was the appropriate setting for February, compared to 60 per cent in December.

He said there was a zero probability of a rate cut (1 per cent in December), while confidence in a needed rate hike was 37 per cent compared to 39 per cent in December.

In the longer term, the probability for a needed rate hike in six months was 71 per cent compared to 69 per cent in December, while the probability of a needed rate hike in 12 months was 81 per cent (76 per cent in December.)

The RBA Shadow Board is a project based at the Centre for Applied Macroeconomic Analysis (CAMA) at the ANU Crawford School of Public Policy. It brings together nine of the country's leading experts to look at the economy and make a probabilistic call on the optimal setting of interest rates ahead of monthly RBA Board meetings. It does not try to predict RBA behaviour.

The RBA Shadow Board includes Professor Bob Gregory and Professor Warwick McKibbin, who have both served on the RBA Board.

Other members are Paul Bloxham of HSBC, Dr Mark Crosby, Professor Guay Lim of the University of Melbourne, James Morley of University of New South Wales, Jeffrey Sheen of Macquarie University, Professor Mardi Dungey of University of Tasmania and John Romalis, Professor of economics at the University of Sydney.

Professor Gregory and Professor Dungey did not vote in the February round.

Dr Henckel's full commentary is available on the CAMA Shadow RBA Board website at https://cama.crawford.anu.edu.au/rba-shadow-board.