No need for more rate cuts: Shadow RBA

1 March 2015

There are clear signs the weaker dollar is helping the domestic economy. However, the danger is that Australia is becoming embroiled in the global currency war.

The Reserve Bank of Australia (RBA) doesn’t need to cut interest rates further after it lowered the official cash rate in February, and might need to start increasing rates in six to 12 months, the ANU RBA Shadow Board has found.

The RBA lowered the cash rate from 2.5 per cent to 2.25 per cent in February and financial markets are anticipating another possible cut over the coming months. The RBA Board will hold its March policy meeting on Tuesday.

RBA Shadow Board chair Dr Timo Henckel said on balance, the RBA Shadow Board believes 2.25 percent to be the appropriate setting.

“The RBA Shadow Board on balance prefers to hold rates and still considers it necessary that the cash rate is lifted in six to 12 months,” said Dr Henckel, from the ANU Centre for Applied Macroeconomic Analysis (CAMA).

He said weak labour market data and weak wages growth would put the brakes on consumer spending and make it less likely that GDP growth would tick up again.

He said confidence measures were mixed, but the fall in the Australian dollar to around 78 US cents, has benefitted the economy.

“There are clear signs the weaker dollar is helping the domestic economy. However, the danger is that Australia is becoming embroiled in the global currency war, whereby countries loosen monetary policy in an attempt to gain international competitiveness,” he said.

“Europe is weak while working through a plan to restructure Greek debt, China is steadying, while the US economy remains the only relative highlight in the world economy.”

He said the Shadow RBA Board attached a 64 per cent probability to interest rates remaining at 2.25 per cent. The probability of the need for a rate cut was 14 per cent, while the likelihood of a needed rate hike was 22 per cent.

In the long term, the probability that the cash rate should remain at 2.25 per cent in six months was 31 per cent, compared to a 56 per cent probability that rates would need to be higher.

The RBA Shadow Board is a project based at 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; 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.