Rates on hold in August despite low inflation: Shadow RBA

31 July 2016

Australia's official interest rates should remain on hold in August as the lowest inflation rate for 17 years continues to make it unlikely that rates will need to rise, The Australian National University (ANU) RBA Shadow Board has found.

The Board of the Reserve Bank of Australia (RBA) lowered the official cash rate by 25 points to a record low 1.75 per cent in May and will meet on Tuesday 2 August to review interest-rate settings for the first time since the Turnbull government was returned to office.

Chair of the RBA Shadow Board Dr Timo Henckel said the Shadow Board's view was growing more dovish, attaching a 54 per cent probability that holding rates steady would be the appropriate setting compared to 63 per cent in July, and with the probability falling on the need for a rate rise.

The probable need for a rate cut in August rose to 28 per cent, compared to 18 per cent in July and just 11 per cent in June. But the probable need for a rate hike has dropped to 18 per cent in August compared to 19 per cent in July and 37 per cent in June.

"The Shadow Board's confidence measures reflect greater concern about downside risks in the economy," Dr Henckel said.

He said June quarter inflation figures found consumer prices rose 1.0 per cent for the year, the lowest inflation rate since 1999 and well below the RBA's target band of two to three per cent. Unemployment edged up to 5.8 per cent in June and the participation rate also increased, but full-time employment also rose by 38,400.

He said next month's data on wages growth would give a more detailed picture of the labour market.

Dr Henckel said financial markets have settled down since the turmoil following the Brexit vote, the Australian dollar has appreciated against the US dollar, and domestic share prices have followed the global lead up and posted significant gains in the past three weeks.

But global uncertainty remains.

"Globally, the storm created by the Brexit vote has been weathered but there remains significant uncertainty about the health of many of the world's large economies," he said.

"Cause for concern are the most recent numbers for the US. Second quarter GDP growth came in at 1.2 per cent, well below the consensus expectation of 2.5 per cent, while first quarter GDP growth was revised down to under 0.8 per cent. These tepid figures can be largely attributed to weak US investment, suggesting that firms remain nervous about the economic outlook," he said.

In the longer term, the Shadow RBA Board placed a 48 per cent probability on the need for rates to increase in six months, unchanged from July but down from 60 per cent in June.

The probability that rates should remain at 1.75 per cent in six months was 23 per cent (unchanged from July), while the probable need for rates to fall in six months was also unchanged at 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.

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