More of the Same as the RBA Decides on Interest Rates for the Last Time this Year

Australia’s economic outlook has not moved much since last month. Growth remains slightly below trend and inflation well contained within the official target band. Weakening commodity prices, a pickup in domestic production, slowing growth in China and Europe and geopolitical uncertainty suggest the most appropriate action is for interest rates to stay on hold. The CAMA RBA Shadow Board continues to recommend with confidence that the cash rate remain at its current level. The Board attaches a 70% probability that the cash rate ought to remain at 2.5% in December. The confidence attached to a required rate cut equals 5%, while the confidence in a required rate hike has increased to 25%.

There is no new data on headline inflation since the previous quarter when it fell 2.3%, largely driven by a fall in electricity prices. Sustained weakness in global energy prices will maintain downward pressure on domestic inflation.

The Australian dollar continues to hover around the 85 US¢ mark, a value many economists consider reflects fundamentals. If domestic interest rates have indeed bottomed out and demand picks up, the Aussie dollar may strengthen a little.

The Australian Bureau of Statistics’s most recent revision puts the unemployment rate at 6.2%. The employment-to-population ratio has dropped to 60.6%, the lowest it has been since late 2004. Without significant improvement of the labour market on the horizon, wages growth is likely to remain muted.

Business investment in capital goods, which includes buildings and equipment, rose 0.2% in the September quarter, well above economists’ expectations of a fall of up to 2%. This suggests that the Australian economy is successfully rebalancing as the mining boom wanes. This rebalancing is reflected in the shift of economic fortunes from the mining states to populous NSW and Victoria, with Sydney’s economy growing more than twice as fast in the last financial year (4.3%) than all other capital cities.

Other business indicators are mixed. Capacity utilization increased slightly to 80.43% in October, as did the manufacturing PMI (from 46.47 in September to 49.42 in October). On the other hand, the Services PMI has fallen from 45.50 to 43.60 in October and the NAB monthly survey of business confidence has slipped slightly from 5 to 4. The Westpac-Melbourne Institute Leading Index of Economic Activity remained steady.

The outlook for the global economy is similar to the previous month’s. Europe, including Germany, risks a major recession while growth of China’s economy is modest. Better news is coming from the USA; however, with the Republicans taking control of Congress in this month’s midterm elections, President Obama will face fierce opposition, giving little hope for any serious structural reforms. The situation in Eastern Ukraine remains highly unstable and Western efforts to combat ISIS in Iraq and Syria continue to pose serious threats to any recovery of the world economy.

The consensus to keep the cash rate at its current level of 2.5% remains virtually unchanged at 70%. The probability attached to a required rate cut equals 5% (6% in October) while the probability of a required rate hike has risen slightly to 25% (23% in October).

The probabilities at longer horizons are as follows: 6 months out, the probability that the cash rate should remain at 2.5% slipped down one percentage point, to 36%. The estimated need for an interest rate increase reverted back to its October value of 56% (54% in November), while the need for a decrease still equals 9%. A year out, the Shadow Board members’ confidence in a required cash rate increase is up 4 percentage points to 71%, the need for a decrease fell to 10% (12% in November), while the probability for a rate hold is 22% (23% in November).