Crawford School of Public Policy

The Reserve Bank of Australia (RBA) should hold interest rates steady at 2.25 per cent ahead of the May 12 budget due to a lack of clear direction for the Australian economy, Crawford School’s RBA Shadow Board has found.

The RBA lowered the cash rate from 2.5 per cent to 2.25 per cent in February and market economists believe the RBA will need to cut rates further and could do so as early as Tuesday’s RBA board meeting.

But RBA Shadow Board chair Dr Timo Henckel said with economic data presenting a mixed view of Australia’s economy, the RBA Shadow Board believes rates should remain steady in May, with the next rate move likely to be an increase.

“Economic data is once again painting a motley picture of the Australian economy,” said Dr Henckel, from the Centre for Applied Macroeconomic Analysis (CAMA).

“Slight improvements in the labour market, stronger commodity prices, and a headline inflation rate near the centre of the official target band stand opposed to weakening consumer sentiment and a deterioration of the international economy. Appreciable risks exist on both the upside and the downside.

“The CAMA RBA Shadow Board on balance prefers to hold firm but still considers it necessary that the cash rate is lifted in 6-12 months.”

Dr Henckel said Australia’s unemployment rate fell slightly in March while wages growth remains muted. The Australian dollar has rebounded from recent lows and yields on Australian 10-year government bonds have also rebounded, suggesting markets are cautiously optimistic about Australia’s short-term economic outlook.

However, international conditions are deteriorating. European growth remains soft and a Greek default is a real possibility, while China is looking to curtail excessive private debt. Statistics from the US also show a weaker than expected first quarter.

“Consequently, the Federal Reserve Bank’s increase of the cash rate may be delayed,” he said.

“On the plus side, international commodity prices have rebounded, benefiting Australia’s mining companies.”

Dr Henckel said the Shadow RBA Board attached a 67 per cent probability, up three percentage points since April, that 2.25 per cent should remain the appropriate setting for official interest rates.

The probability of the need for a rate cut in May was 13 per cent (16 per cent in April), while the likelihood of a needed rate hike was 20 per cent (19 per cent in April).

In the long term, the probability that the cash rate should remain at 2.25 per cent in six months was down two percentage points since April to 29 per cent in May. The probability that rates would need to be higher in six months was 55 per cent, up from 53 per cent a month ago.

The probability of a needed rate cut in six months was unchanged since April at 16 per cent.

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.