Rates on hold despite pickup in economic growth – ANU SHADOW RBA

2 October 2017

Eventually, the growing tightness of the labour market ought to spill over into higher wages.

Australia's official interest rates should remain on hold in October despite encouraging economic growth figures for the second quarter and a rise in full-time employment, 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 2016.

Chair of the RBA Shadow Board Dr Timo Henckel said Australia's economic outlook was more positive, but inflation and wages growth both remained subdued.

"Combined with favourable employment figures and an improved outlook for the global economy, the case for increasing the cash rate in the future is building. However, for this month the RBA Shadow Board continues to advocate a hold-and-wait policy," Dr Henckel said.

Figures released in September found Australia's unemployment rate held steady at 5.6 per cent but with more than 54,000 new jobs created in August. However, the labour force participation rate rose for the sixth consecutive month, from 65.1 per cent to 65.3 per cent, preventing the increase in jobs from lowering the official unemployment rate.

Dr Henckel said the responsiveness of labour force participation to the creation of job vacancies, along with unremarkable productivity growth, helps keep a lid on wages growth and thus on overall inflation.

"Eventually, the growing tightness of the labour market ought to spill over into higher wages," he said.

Official economic growth figures for the second quarter found the economy grew by 0.8 per cent in the three months to the end of June, and 1.8 per cent for the year, rebounding from 0.3 per cent for the first quarter of 2017.

Dr Henckel said the outlook for the global economy continues to brighten.

"Global share markets continue to make steady gains and the US Federal Reserve Bank's rhetoric clearly points to further increases in the federal funds rate," he said.

"So far financial markets do not seem concerned about the sabre rattling between the US and North Korea, but that may change rapidly if the prospect of war becomes more likely."

Dr Henckel said the RBA Shadow board attached a 60 per cent probability that that holding rates steady was the appropriate setting for October, down from 61 per cent in September.

The confidence attached to a needed rate cut was up to six per cent for October from two per cent for September, while confidence in a needed rate hike was up to 39 per cent from 37 per cent last month.

In the longer term, the probability for a needed rate hike in six months was up four points to 73 per cent compared to 69 per cent for September.

The probability that rates should remain at 1.5 per cent in six months was 21 per cent (24 per cent in September), while the probable need for rates to fall in six months was six per cent compared to seven per cent last month.

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.

Professor Romalis did not vote this month.

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