Rates on hold with no key economic news- Shadow RBA

4 April 2016

The past month has brought little in the way of news about the health of the world economy.

Australia had no need to change interest rates in April with an absence of major economic news at home and abroad leading to an almost boring consensus on monetary policy, the 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 Tuesday to review interest-rate settings.

RBA Shadow Board chair Dr Timo Henckel said global markets have rebounded from the turmoil at the start of the year and volatility has declined noticeably, with the RBA Shadow Board strongly in favour of keeping rates on hold.

"Former Bank of England Governor Sir Mervyn King famously wrote that 'a successful central bank should be boring'. The recent consensus in monetary policy, given the absence of major news about the Australian and overseas economies to inform policy makers, appears to be just that," Dr Henckel said.

He said the unemployment rate has fallen to 5.8 per cent and inflation at 1.7 per cent remains well below the RBA target band of two to three per cent.

Economic growth came in at an annual 3.0 per cent at the end of 2015, fuelled by stronger household spending and government expenditure, while investment declined by 0.6 per cent in the fourth quarter, subtracting from GDP growth. Yet real domestic income increased by only 0.1 per cent in the fourth quarter, reflecting a decrease in Australia's terms of trade.

"Overall, the outlook for the Australian economy looks much the same as the previous month," Dr Henckel said.

"The RBA Shadow Board's policy preferences remain virtually unchanged from last month. It continues to have a strong preference for keeping the cash rate on hold, attaching a 69 per cent probability to this being the appropriate policy setting, up one point from March.

"The confidence attached to a required rate cut equals 23 per cent (22 per cent in March),  while the confidence in a required rate hike only equals eight per cent (10 per cent in March)."

Dr Henckel said while the unemployment rate had fallen, the drop was almost entirely due to a fall in the participation rate from 65.1 per cent to 64.9 per cent. He said the markets would be watching for new data on wages growth, which remains worryingly subdued.

Internationally, global stocks have rebounded and market volatility has declined steadily since February.

"The past month has brought little in the way of news about the health of the world economy. The US economy still looks to be the pacemaker, with Europe, Japan, the BRICS countries and other developing economies expanding only modestly," he said.

"High indebtedness in many countries remains a concern, even at historically low interest rates."

In the longer term, the Shadow RBA Board placed a 45 per cent per cent probability on the need for rates to increase in six months, down two points from a month ago. The probability that rates should remain at 2.0 per cent remained at 30 per cent, and the probability of a needed rate cut in six months was 25 per cent compared to 23 per cent in March.

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.