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The Reserve Bank of Australia (RBA) should keep interest rates on hold after its February board meeting, with a fall in global oil prices and a lower Australian dollar to help stimulate the domestic economy, Crawford School’s RBA Shadow Board has found.
The RBA’s official cash rate has been set at 2.5 per cent since August 2013. The RBA Board will hold its February policy meeting on Tuesday, with some market economists suggesting it might need to cut interest rates. But RBA Shadow Board chair Dr Timo Henckel said while Australia’s economic outlook was uncertain, core inflation remained within the RBA’s target band of two to three per cent.
“The RBA Shadow Board continues to recommend with confidence that the cash rate be held at its current level of 2.5 per cent,” said Dr Henckel, from the Centre for Applied Macroeconomic Analysis (CAMA).
“Core inflation, a measure of inflation that excludes volatile items such as energy and food, currently lies at 2.1 per cent - within the official inflation target band. It suggests that the drop in energy prices does not call for an immediate reduction in the cash rate.
“After an extended period of low volatility, during which the Australian dollar hovered around the 85 US¢ mark, the currency has fallen another 8 US¢. If the dollar remains below 80 US¢ for some time, exports, in particular the tourism and education sectors, should expand appreciably and boost domestic production.”
He said the Shadow RBA Board attached a 68 per cent probability to interest rates remaining at 2.5 per cent. The probability of the need for a rate cut was 13 per cent, up from five per cent in December, while the likelihood of a needed rate hike fell to 19 per cent in February from 25 per cent in December.
In the long term, the probability that the cash rate should remain at 2.5 per cent in six months rose 10 points from December to 46 per cent in February. The probable need for a rate cut in six months rose seven points to 16 per cent.
The probable need for a rate increase in six months fell to 38 per cent from 56 per cent in December.
The RBA Shadow Board is a project based at 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 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.