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05 June 2016

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Professor Warwick McKibbin is an ANU Public Policy Fellow at Crawford School. Professor McKibbin was a member of the Board of the Reserve Bank of Australia from 2001- 2011. He teaches Modelling the World Economy: techniques and policy implications (IDEC8127).

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Official interest rates have probably hit the bottom and gone as low as they need to go, with the next change more likely to be a needed rate increase rather than another cut, Crawford School’s RBA Shadow Board has found.

The Board of the Reserve Bank of Australia (RBA) lowered the official cash rate by 25 points to a record low 1.75 per cent in May and will meet on Tuesday 7 June to review interest-rate settings.

Chair of the RBA Shadow Board Dr Timo Henckel said the Shadow Board consensus was that rates would remain steady in June, but the Shadow Board was more hawkish on the need for rates to rise in the next six months.

“The nadir of the interest rate cycle is probably reached,” Dr Henckel said.

“Relative to last month, the RBA Shadow Board’s policy preferences have become more hawkish,” he said, adding that partly reflects the Shadow Board’s consensus against a rate cut in May.

Dr Henckel said the Shadow Board attached a 52 per cent probability on the need for rates to remain on hold in June, with only an 11 per cent probability for another rate cut. It attached a 37 per cent probability on a rate rise in June.

In the longer term, however, the Shadow RBA Board placed a 60 per cent probability on the need for rates to increase in six months, up by 18 points on its position a month ago.

The probability that rates should remain at 1.75 per cent in six months was 24 per cent, while the estimated need for rates to fall in six months was 16 per cent.

On the domestic economy, Dr Henckel said Australia’s GDP growth was surprisingly strong in the March quarter and could end up a healthy 3.0 per cent annually for the 2015-16 fiscal year, while the unemployment rate remains steady at 5.7 per cent.

But the global economy continues to paint a motley picture.

“The US economy is continuing to grow near potential. But other countries are not faring so well. Russia is hoping its economy will start growing again later this year while Brazil just announced its economy contracted by 5.4 per cent year-on-year in the first quarter,” he said.

“China’s growth rate is expected to be between 6.0 per cent and 7.0 per cent. Recent announcements by the Chinese government of large-scale infrastructure projects are no doubt meant to breathe new life into the Chinese economy. “Europe’s economies are expanding modestly, Japan is standing still and there remains uncertainty surrounding the resilience and strength of the world’s developing economies, especially those carrying large debt burdens.”

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 behavior.

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.

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