Case Building for Rates To Rise, But Not Yet

Official economic growth figures for the second quarter found the Australian economy grew by 0.8 per cent in the three months to June, and 1.8 per cent for the year, rebounding from 0.3 per cent for the first quarter of 2017. Combined with favourable employment figures and an improved outlook for the global economy, the case for increasing the cash rate in the future is building. However, for this month the RBA Shadow Board continues to advocate a hold-and-wait policy. It attaches a 60% probability that this is the appropriate setting. The confidence attached to a required rate cut equals 6%, while the confidence in a required rate hike equals 39%.

Figures released in September found Australia’s seasonally adjusted unemployment rate held steady at 5.6%, according to the Australian Bureau of Statistics, but with more than 54,000 new jobs created in August, of which 40,000 were full-time. The labour force participation rate rose for the sixth consecutive month, from 65.1% to 65.3%, preventing the increase in jobs from lowering the official unemployment rate. The responsiveness of labour force participation to the creation of job vacancies, along with unremarkable productivity growth, helps keep a lid on wages growth and thus on overall inflation. Eventually, the growing tightness of the labour market ought to spill over into higher wages.

The Aussie dollar, relative to the US dollar, has retreated from a temporary high of 81 US¢ to around 78 US¢. Yields on Australian 10-year government bonds have edged up to 2.85%, suggesting financial markets are beginning to expect a future increase in interest rates. Share prices remain range-bound, with the S&P/ASX 200 stock index’s last reading just below 5700.

The outlook for the global economy continues to brighten. Global share markets continue to make steady gains and the Federal Reserve Bank’s rhetoric clearly points to further increases in the federal funds rate. So far financial markets do not seem concerned about the sabre rattling between the US and North Korea but that may change rapidly if the prospect of war becomes more likely.

The distribution of the Shadow Board’s policy preferences has shifted down slightly. The Shadow Board is 60% confident that keeping interest rates on hold is the appropriate policy, one percentage point down from the previous month. It attaches a probability of 6% that a rate cut is appropriate (2% in September) and a 39% probability (37% in September) 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 21%, three percentage points lower than in September. The estimated need for an interest rate decrease is 6% (7% in September), while the probability attached to a required increase equals 73% (69% in September). A year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 15% (16% in September), while the confidence in a required cash rate decrease equals 8% (9% in September), and in a required cash rate 78% (76% in September).