Crawford School of Public Policy

The Shadow RBA says Australia’s central bank should leave official cash rate steady ahead of Federal budget.

The Reserve Bank of Australia should leave interest rates unchanged ahead of the federal budget despite some promising signs for the domestic economy, Crawford School’s RBA Shadow Board has found.

“Latest economic news shows some promising signs for the Australian economy. However, the new government’s first budget, to be announced on 14 May, is a big unknown,” said shadow board chair Dr Timo Henckel.

The RBA Shadow Board is a project based at the Centre for Applied Macroeconomic Analysis (CAMA) at 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 interest rates ahead of monthly RBA Board meeting.

The RBA Board will meet this Tuesday.

Dr Henckel said the RBA Shadow Board was 74 per cent confident that the cash rate should remain steady at 2.5 per cent. The probability attached to a required rate cut equals six per cent while the probability of a required rate hike was 20 per cent, down from 25 per cent last month.

In the long term, the probability that the cash rate should remain at 2.5 per cent in six months edged down to 37 per cent from 39 per cent in April. The probability that the interest rate should increase in six months remains at 48 per cent, while the probable need for a rate cut has risen slightly to 16 per cent from 12 per cent in April.

“The big unknown for Australia is the forthcoming federal government budget,” Dr Henckel said.

“It will likely be contractionary for the economy overall as the Coalition government seeks to reduce spending in a long-term effort at balancing the budget. Moreover, there is much speculation about the distributive implications of the budget. If the budget turns out to be tight and regressive, it will reduce aggregate demand and increase the likelihood that interest rates remain low.”

Australia’s unemployment rate fell to 5.8 per cent in March, while inflation lies barely above the middle of the RBA’s target band of two to three per cent. The Australian dollar has held up during the past month, now valued at 93 US cents. Asset markets, in particular housing, remain buoyant. Domestic consumption and production indicators are continuing their modest upward trend.

Internationally, the clouds appear to be lifting ever so slightly. US economic data is improving and the Federal Reserve Board announced a further reduction of its asset purchasing program. Several European crisis countries, foremost Greece, are finally showing signs of rebounding. In particular, their improved access to international credit markets at favourable conditions has surprised many analysts. China’s growth is slowing, and the possibility of a credit crunch remains real, but a growth rate of seven per cent is considered by many to be a lower bound.

The RBA Shadow Board includes ANU professors Bob Gregory and Professor Warwick McKibbin, who have both served on the RBA Board.

Other members are Paul Bloxham of HSBC; Dr Mark Crosby and Saul Eslake of Bank of America Merrill Lynch; Adjunct Professor Guay Lim of the University of Melbourne; James Morley of University of New South Wales; Jeffrey Sheen of Macquarie University; and Mardi Dungey of University of Tasmania.

The Shadow RBA’s full recommendation can be read at the CAMA website: https://cama.crawford.anu.edu.au/