Interest Rates Should Hold: RBA Shadow Board

There is little economic news, not even OPEC’s decision to cut oil output, to justify a change in the current cash rate. Unemployment fell yet again, albeit slightly, and consumer price inflation, at 1.0% year-on-year, remains well below the RBA’s 2-3% target band. The CAMA RBA Shadow Board clearly believes that the cash rate should remain at its current level. The Shadow Board attaches a 65% probability to a rate hold being the appropriate policy setting. The confidence attached to a required rate cut equals 6%, while the confidence in a required rate hike equals 29%.

Australia’s unemployment rate fell another 0.1 percentage points, to 5.6%, according to the Australian Bureau of Statistics. The participation rate, too, fell slightly; it now stands at 64.7%. The labour market was pretty calm this month: full time employment increased by 11,500 and part-time employment decreased by 15,400. There is no new data for the seasonally adjusted wage price index.

The Aussie dollar, relative to the US dollar, has continued its sideways movement, trading between 74 US¢ and 77 US¢. After a long secular decline, yields on Australian 10-year government bonds bounced back a little, standing now at just under 2%. Domestic share prices, after a brief drop in mid-September rebounded to their previous levels.

The biggest news on global markets has been the surprise mid-week announcement by the Organization of the Petroleum Exporting Countries (OPEC), which accounts for approx. 70% of the world’s proven oil reserves, to modestly cut oil output. This is the first such agreement by OPEC since 2008. Markets reacted instantaneously with futures prices rising 7% by the end of the week. This agreement is unlikely to have major ramifications for the global economy, as OPEC is a notoriously unstable cartel, representing a declining share of overall oil output, but it may temporarily halt the secular decline in commodities prices.

The Federal Reserve Bank in the US is still debating when to raise interest rates. In spite of solid economic data, the Fed remains cautious. Increasingly, attention will be directed at the US Presidential election, held on 8 November. Officially, China’s economy continues to grow at just under 7% but numerous Western commentators, who distrust the sanguine official numbers, point to the country’s high levels of debt and the likelihood of a hard landing.

Consumer confidence, as measured by the Westpac-Melbourne Institute Consumer Sentiment Index, is unchanged from the previous month, while month-on-month retail sales are flat. Numbers for the manufacturing PMI, which measures the performance of the manufacturing sector based on surveys of 200 industrial companies, have yet to be released. Last month’s significant fall in the manufacturing PMI has been followed by an equally dramatic decline in the services PMI (to 45, its lowest reading in 18 months). The AIG Performance of Construction Index (PCI) dropped significantly from 51.6 in July to 46.6 in August, just above the long-run average for the past 10 years.

The Shadow Board attaches a 65% probability (57% last month) that “no change” is the appropriate policy, a 6% probability (5% last month) that a rate cut is appropriate and a 29% probability (38% in the previous month) 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 27%, three percentage points up from the previous month. The estimated need for an interest rate decrease equals 13% (11% in September), while the need for a rate increase equals 61% (65% in September). A year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 16% (18% in September), while the confidence in a required cash rate decrease is unchanged at 10% and the confidence in a required cash rate increase equals 73% (72% in September).