October 15, 2019

Australian Markets Weekly: Assessing “lower for longer” interest rates using RBA’s macro model

We used the MARTIN model to explore holding the cash rate at low levels for a longer period of time.

For the full picture, download the report: Australian Markets Weekly: 14 October 2019 

Analysis:  Assessing “lower for longer” interest rates using the RBA’s macro model

  • As it approaches the limits of conventional monetary policy, the Reserve Bank has strengthened its forward guidance, stating that “it is reasonable to expect that an extended period of low interest rates will be required to reach full employment and achieve the inflation target”.  Although the Reserve Bank has not specified a time period to achieve these goals, a typical policy cycle lasts one to two years and the bank’s own forecasts suggests rates could stay low for at least two years.
  • Normal rules-of-thumb on the effectiveness of interest rates are based on modelling of a rate cut that lasts one year.  We used the MARTIN model to explore the Reserve Bank’s guidance by estimating the impact of holding the cash rate at low levels for a longer period of time. We found that the longer the cash rate is held at low levels, the larger the impact on the economy. The results also underscore how higher house prices and a lower exchange rate are part and parcel of the transmission mechanism of lower interest rates.
  • Notwithstanding some limitations of the MARTIN model – particularly around the assumption that the neutral interest rate remains unchanged in our scenario work – the results demonstrate that the level of the cash rate matters.   Given conventional monetary policy is close to exhaustion, we plan to extend this work by using the model to explore the impact of fiscal policy on the economy, although we are mindful that the model was not designed for such a purpose.

The week ahead: NAB business survey; US-China trade talks

  • In Australia, the October RBA Board minutes are released on Tuesday and should maintain the dovish tone adopted in post-meeting press release, which emphasised the goal of full employment. On Thursday, unemployment should hold at 5.3% in September (market: 5.3%) alongside weaker employment growth of 10k (market: 17k). We expect Wednesday’s NZ CPI to rise 0.7% in Q3 and 1.5% over the year, compared with the RBNZ’s August MPS expectation of a 0.5% quarterly increase. Importantly, a good part of the upward surprise for the RBNZ will likely come in the non-tradable element, suggesting an upward bias to core inflation.
  • Globally, markets will digest the partial ceasefire in the US-China trade war.  On Friday, China’s annual GDP growth is expected to tick down to 6.1% in Q3. Industrial production the same day should reflect weak manufacturing growth. US retail sales are due Wednesday, with industrial production on Thursday. There is an EU Summit on 17-18 October. We still expect an extension past the 31 October deadline, but a deal is possible. The US is due to impose tariffs on the EU on 18 October in response to illegal state subsidies to Airbus.  August industrial production on Monday will likely be weak.

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