Strong dollar, low inflation allow rates to stay on hold - Shadow RBA

30 July 2017

A strong Australian dollar and low inflation mean Australia's official interest rates should remain on hold in August despite signs of improving economic health, The Australian National University (ANU) RBA Shadow Board has found.

The board of the Reserve Bank of Australia (RBA) will meet on Tuesday to review official interest rates, which have been at a record low of 1.5 per cent since August last year.

Chair of the RBA Shadow Board Dr Timo Henckel said strong growth in full time jobs in June, and an increased participation rate, pointed to an overall improvement in the nation's economic health.

But official inflation fell from 2.1 per cent to 1.9 per cent in the June quarter, below the Reserve Bank's 2-3 per cent target band, while the Australian dollar has hit two-year highs and traded above US80 cents in recent weeks, helping to further contain prices.

"Consequently, the RBA Shadow Board continues to advocate a hold-and-wait policy," Dr Henckel said.

"The Aussie dollar, relative to the US dollar, after falling the previous month has continued its surprise appreciation, trading above US80 cents late this month. This helps keep a lid on inflation by lowering import prices and slowing aggregate demand."

Dr Henckel said while the economy added 62,000 full time jobs in June, the youth unemployment rate rose to above 13 per cent, which was a worrying sign. And weak nominal wage growth of under 2.0 per cent appears to be the new normal.

The international economy was showing no new surprises.

"China is looking to de-lever slowly. The US economy is expanding, pointing to further tightening of US monetary policy. European growth is also looking solid though there are little signs that the European Central Bank is considering monetary tightening in the near future," Dr Henckel said.

"Australia continues to post a trade surplus with the rest of the world but the current account remains in deficit."

Dr Henckel said the RBA Shadow board attached a 60 per cent probability that that holding rates steady was the appropriate setting for August, up from 59 per cent in July.

The confidence attached to a needed rate cut was unchanged at two per cent, while confidence in a needed rate hike was down to 38 per cent from 39 per cent last month.

The RBA Shadow Board said in the longer term, the probability for a needed rate hike in six months was 68 per cent, compared to 71 per cent in July.

The probability that rates should remain at 1.5 per cent in six months was 25 per cent (23 per cent in July), while the probable need for rates to fall in six months was seven per cent (six per cent in July).

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.

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