Hold-and-Wait Best Policy: RBA Shadow Board

Economic indicators for Australia look benign – at least for the moment. Recent revisions to their economic forecasts by leading financial institutions reveal that another quarter of economic contraction, following the September quarter 2016, may be on the cards. Last month’s budget is unlikely to significantly alter the outlook, nor are the developments overseas. The RBA Shadow Board continues to advocate a hold-and-wait policy. It attaches a 56% probability that this is the appropriate setting. The confidence attached to a required rate cut equals 3%, while the confidence in a required rate hike equals 42%.

Headline inflation, which increased to 2.1% in the March quarter, lies comfortably within the Reserve Bank of Australia’s official target range of 2-3%. Australia’s seasonally adjusted unemployment rate fell to 5.7 percent in April, according to the Australian Bureau of Statistics, with the economy adding more than 35,000 jobs. However, this increase was due entirely to a swell in part-time employment as full-time employment contracted by nearly 12,000. Nominal wage growth continues to remain subdued. In fact, in the March quarter real wages fell by 0.2%.

The Aussie dollar, relative to the US dollar, recently fell below the 74 US¢ mark, with some financial market analysts predicting a breach of the 70 US¢ threshold before the end of the year. Yields on Australian 10-year government bonds continue to slide; they now equal 2.4%. Domestic share prices have pared their recent gains, with the S&P/ASX 200 stock index trading below 5,800.

Commodity export prices dropped a considerable 6.8% in May; they are now more than 10% below their January peaks. Even though mining investment increased slightly for the first time in nearly three years, it is expected to fall 22% in the year ahead, based on ABS surveys. Non-mining firm investment is expected to increase by 3.7% in the same period.

Internationally, there exists no stand-out news item to help guide policy. Economic statistics from Europe and the US look favourable but geostrategic conflicts, uncertain elections and unpredictable US policy could change this swiftly. China is unlikely to experience another round of double-digit growth rates. On the contrary, there remains the possibility that the debt overhang and structural adjustment will further slow the economy.

Consumer and business confidence remain modest. Other measures of economic activity such as capacity utilization, retail sales and inventory behavior remain tightly range-bound.

The Shadow Board’s policy preferences have barely nudged since last month. It is 56% confident that keeping interest rates on hold is the appropriate policy, one percentage point down from May. It attaches an unchanged probability of 3% that a rate cut is appropriate and a 42% probability (40% in May) 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%, unchanged from the previous round. The estimated need for an interest rate decrease is up two percentage points, from 4% to 6%, while the probability attached to a required increase equals 71% (73% in May). A year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 14% (17% in the previous month), while the confidence in a required cash rate decrease edged up from 4% to 7% and in a required cash rate increase remained unchanged at 79%.