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Stronger than expected economic growth provides welcome news to the Australian people. Coupled with a lack of new data on inflation, the unemployment rate hardly moving and no clear direction for the global economy, the CAMA RBA Shadow Board’s conviction that the cash rate should remain at its current level has weakened a little. The Shadow Board attaches a 59% probability to a rate hold being the appropriate policy setting. The confidence attached to a required rate cut equals 4%, while the confidence in a required rate hike equals 37%.
The Australian economy expanded 1.1% in the last quarter of 2016, more than the forecast 0.7% and a welcome reversal of the contraction in the previous quarter. This is good news but it remains to be seen whether strong growth can be maintained throughout the year.
Inflation remains at 1.5%, well below the Reserve Bank of Australia’s official target of 2-3%. Since the last Shadow Board round the unemployment rate fell slightly from 5.8% to 5.7%, according to the Australian Bureau of Statistics. The labour market continues to be volatile, however, with the large drop in full-time employment (-44,800) more than offset by the surge in part-time employment (+58,340). There is no new data on wages growth.
The Aussie dollar, relative to the US dollar, continues to trade in a narrow range, around 76 US¢. Yields on Australian 10-year government bonds are also range-bound, around 2.8%. Domestic share prices, too, are going sideways, reflecting the drop in volatility of stock prices worldwide.
The world economy is lacking a clear direction. There still exists uncertainty about the Trump presidency and about Europe, with key elections in France, Germany and the Netherlands looming later this year. The Asian economies appear to be getting by; however, South America, particularly Brazil, is faring poorly. Relative to the underlying fundamentals, global share markets look overvalued.
Consumer and business confidence measures continue to show mixed signs, with consumer confidence, as measured by the Westpac-Melbourne Institute Consumer Sentiment Index, and the manufacturing PMI rising and the services PMI falling. Similarly, the construction PMI and building permits edged up whereas actual new home sales fell.
House prices are continuing their upward trend. Sydney and Melbourne house prices climbed 4.5% and 5.5%, respectively, in the three months to February. Together with Australia’s household debt-to-GDP ratio reaching an all-time high of 123%, the third highest in the world, the Organization for Economic Cooperation and Development in a recent report warned of the possibility of a painful price correction, with significant implications for the macroeconomy likely.
The Shadow Board’s continues to prefer to hold interest rates steady but it attaches more probability to the possible need of a rate rise. It now attaches a 59% probability (70% in February) that “no change” is the appropriate policy, a 4% probability (5% in February) that a rate cut is appropriate and a 37% probability (25% in February) 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 23%, one percentage point down from the previous round. The estimated need for an interest rate decrease remains unchanged at 9%, while the need for a rate increase equals 68% (67% in February). A year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 17% for the third month in a row, while the confidence in a required cash rate decrease (7%) and in a required cash rate increase (76%) are also virtually unchanged.
Despite announcements in the US about some policies the economic outlook there and in other parts of the globe remains uncertain. While financial markets remain optimistic, it would seem sensible for policy to remain cautious in coming months.
We are going through a fairly steady period where interest rate cuts are likely not to help even though the labour market is very weak.
The latest GDP print (1 March 2017) suggests an improvement in confidence amongst households and firms. Much of this comes from a slowly improving terms of trade that has helped to raise profits, but there remains a risk into the future from continuing low real wage growth. Further cuts in the cash rate will not make much difference at the margin to improving confidence, but care is needed to avoid counterproductive pre-emptive rises in the rate. Confidence improvements should instead come from fiscal innovations in Canberra.
Updated: 25 February 2016/Responsible Officer: Crawford Engagement/Page Contact: CAMA admin
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