Outcome: November 2017

No Melbourne Cup Rate Rise But Future Increase Looking More Likely

Consumer price inflation was 1.8% in the third quarter, below the consensus forecast of 2% and also below the Reserve Bank of Australia’s official target band 2-3%. This drop is likely to be transitory as it is largely attributed to a fall in food prices. Favourable employment figures and an improving outlook for the global economy increase the likelihood that interest rates need to rise in the future. For this month the RBA Shadow Board continues to advocate a hold-and-wait policy. It attaches a 60% probability that this is the appropriate setting. The confidence attached to a required rate cut equals 2%, while the confidence in a required rate hike equals 38%.

Figures released in October found Australia’s seasonally adjusted unemployment rate fell by another 0.1%, to 5.5%, according to the Australian Bureau of Statistics, the lowest jobless rate since May, even though employment went up by a mere 19,800. The labour force participation rate held steady at 65.2%. No new data on wage growth has been released, a number to be watched closely as it remains surprisingly subdued, given the tightness in the labour market.

The Aussie dollar, relative to the US dollar, after retreating from a temporary high of 81 US¢ in the previous month, has recently been trading near the 77 US¢ mark. Yields on Australian 10-year government bonds have fallen considerably to below 2.6%, reflecting the unexpected drop in inflation. The local stock market broke out on the upside, the S&P/ASX 200 stock index’s closing just below 6000.

The expansion of the global economy is gathering pace. Global share markets continue on their bull run, raising growing concerns that share and bond prices are trading well above their fundamental values and that a major correction is due. More and more central banks are expected to lift rates, or already have.

The distribution of the Shadow Board’s policy preferences has shifted slightly to the upside. The Shadow Board is 60% confident that keeping interest rates on hold is the appropriate policy, unchanged from the previous month. However, it only attaches a probability of 2% that a rate cut is appropriate (6% in October) and a 38% probability (39% in October) that a rate rise, to 1.75% or higher, is appropriate.

The probabilities at longer horizons are as follows: 6 months out, the estimated probability that the cash rate should remain at 1.50% equals 24%, three percentage points higher than in October. The estimated need for an interest rate decrease is 6% (unchanged), while the probability attached to a required increase equals 70% (73% in October). A year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 16% (15% in October), while the confidence in a required cash rate decrease equals 7% (8% in September), and in a required cash rate increase 78% (unchanged).