Interest rates should remain steady, says RBA Shadow Board

The Australian National University’s RBA Shadow Board says interest rates should remain on hold.

The call comes on the back of signs of a weakening Australian economy, including falling inflation.

The Reserve Bank of Australia (RBA) will meet on Tuesday 7 May to review interest-rate settings, which have been at a record low of 1.5 per cent since August 2016.

Dr Timo Henckel said the RBA Shadow Board’s conviction was the cash rate should remain on hold.

However, the RBA Shadow Board’s conviction has weakened slightly.

“The perceived risks have shifted dramatically from previous months. The Board is 54 per cent confident that keeping interest rates on hold is the appropriate policy, down seven percentage points from April,” Dr Henckel said.

“It now attaches a 38 per cent probability that a rate cut is appropriate, compared to 6 per cent in April.

“The RBA Shadow Board attaches only an 8 per cent probability that a rate rise is appropriate – compared to 33 per cent in April.”

Significantly, Australia’s inflation rate fell to 1.3 per cent in the March quarter, putting it well below the RBA’s official target band of 2-3 per cent.

The unemployment rate ticked up to 5 per cent in March, while consumer and business confidence measures improved slightly.

“Signals about the state of the world economy are mixed,” Dr Henckel said.

“Federal Reserve chairman Jerome Powell is sounding more confident about the US economy. The US yield curve, usually a good predictor of economic fortunes, is slightly upward-sloping, after having briefly inverted in March.

“A more bullish economic outlook in the US creates a bigger gap between yields in the US and Australia, and may well fuel a further depreciation of the Australian dollar.”

Australia’s real estate sector continues to weaken, with experts forecasting further declines in house prices.

“Coupled with a weakening macroeconomy, this will raise households’ financial stress and choke aggregate demand,” Dr Henckel said.

Looking ahead for the next six months, the RBA Shadow Board’s estimated probability that the cash rate should remain at 1.5 per cent has jumped 11 percentage points, to 38 per cent.

The probability of an interest rate cut in the next six months has increased from 28 per cent to 38 per cent, while the probability attached to a rate hike has fallen further, to 24 per cent.

The RBA Shadow Board is a project based at the Centre for Applied Macroeconomic Analysis (CAMA) in 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.

Dr Henckel’s full commentary is available on the CAMA RBA Shadow Board website.

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