No need for RBA to upstage the Budget - Shadow RBA

2 May 2016

The RBA Shadow Board's policy preferences have turned mildly more accommodative although there remains a strong consensus for keeping the cash rate on hold

The Reserve Bank had no need to cut interest rates and upstage the Turnbull government's pre-election budget on Tuesday despite falling consumer prices and a relatively high Australian dollar, The Australian National University (ANU) RBA Shadow Board has found.

The Board of the Reserve Bank of Australia (RBA) lowered the official cash rate from 2.25 per cent to 2.0 per cent in May 2015 and will meet on Budget day, Tuesday 3 May, to review interest-rate settings.

The financial markets have factored in a potential rate cut in the coming months following weak inflation data, but RBA Shadow Board chair Dr Timo Henckel said the new inflation numbers did not warrant a rate cut.

"The RBA Shadow Board's policy preferences have turned mildly more accommodative although there remains a strong consensus for keeping the cash rate on hold," Dr Henckel said.

"Consumer prices unexpectedly fell 0.2 per cent in the first quarter of this year, driven by lower prices for energy and fresh food items. The annual CPI rose 1.3 per cent, well below the RBA's target band of 2-3 per cent. The Reserve Bank's preferred measure of core inflation, which excludes volatile items such as food and energy, rose 0.2 per cent in the quarter, slightly less than widely expected.

"The unemployment rate fell to 5.7 per cent, while the global economy continues to expand only modestly."

He said as markets assess the likelihood of a rate cut in the coming months, the Australian dollar, trading at around 77 US cents, might experience further selling pressure.

Internationally, he said global stocks and commodities continued to advance, but there has been no substantive news to prompt policy makers revise their view of the tepid state of the world economy.

Dr Henckel said the Shadow Board attached a 63 per cent probability on the need for rates to remain on hold, compared to 69 per cent in April.

It attached a 29 per cent probability on a needed rate cut (23 per cent last month), and only an eight per cent probability on a needed rate rise, unchanged from April.

In the longer term, the Shadow RBA Board placed a 42 per cent per cent probability on the need for rates to increase in six months, down three points from a month ago. The probability that rates should remain at 2.0 per cent was 29 per cent, down from 30 per cent in April, and the probability of a needed rate cut in six months was up four points since April to 29 per cent.

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 behavior.

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; Mardi Dungey of University of Tasmania; and John Romalis, Professor of economics at the University of Sydney.

Jeffrey Sheen and John Romalis did not vote in this 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.