Rates on hold under election, Brexit uncertainty

4 July 2016

Without new economic data to go by, it is the political uncertainty that dominates the outlook.

Australia's official interest rates should remain on hold in July against a backdrop of political uncertainty over the Australian election and Britain's vote to leave the European Union, the ANU RBA Shadow Board has found.

However, the Chair of the RBA Shadow Board Dr Timo Henckel said the Shadow Board's view was more dovish compared to last month, attaching a 63 per cent probability that holding rates steady would be the appropriate setting compared to 52 per cent in June, and with a lower probability on the need for a rate rise.

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 5 July to review interest-rate settings.

"The unexpected outcome of the Brexit vote in the United Kingdom injected a good dose of uncertainty and volatility into financial markets, especially in Europe and the UK," Dr Henckel said.

"A flight to safety saw the US dollar appreciate relative to other currencies and, while currencies and stock markets have settled down, the Brexit vote will likely echo for a long time to come, durably changing the European political landscape.

"Domestically, the federal election has turned out much closer than many expected and it could be some time before the result is finalised.

"Without new economic data to go by, it is the political uncertainty that dominates the outlook."

Dr Henckel said the probability for a needed rate rise had fallen to 19 per cent for July, down from 37 per cent a month ago. The probable need for a rate cut was 18 per cent compared to 11 per cent in June.

In the longer term, the Shadow RBA Board placed a 48 per cent probability on the need for rates to increase in six months, 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 (24 per cent in June), while the probable need for rates to fall in six months was 29 per cent (16 per cent in June).

"In the wake of the Brexit vote, the global economic outlook is currently dominated by politics, with elections looming in a number of countries and uncertainty in Europe and elsewhere working its way through the global economy," Dr Henckel said.

"The direct effect of the Brexit outcome on the Australian economy should be minimal but through global capital markets and international trade this far-away event may eventually be felt after all."

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.