Neutral cash rate a guide, says RBA

Ultra-low interest rates are clearly no longer appropriate but a senior central bank official says the road to “neutral” remains flexible.

Assistant governor Luci Ellis has provided guidance on how the Reserve Bank of Australia views the challenge of identifying the neutral cash rate.

Put simply, this is the level where interest rates have neither a stimulatory nor contractionary effect on the economy.

Speaking at the Citibank Conference in Sydney on Wednesday, Ms Ellis stressed there were many variables involved and the central bank was not taking a prescriptive return path to “more normal” levels.

“Don’t think of this as a mechanistic approach of ‘we have to get back to neutral or above neutral’,” she said.

“The neutral rate is an important guide rail for thinking about the effect policy might be having. It is not necessarily a prescription for what policy should do.”

The RBA has been aggressively lifting interest rates from record lows in a bid to tame inflation, although it shifted to a gentler pace of tightening in October.

With the cash rate sitting at 2.6 per cent, the slowdown could suggest it’s getting closer to the neutral rate.

The RBA has previously predicted a neutral level of somewhere between 2.5 and 3.5 per cent.

Ms Ellis also reiterated the central bank’s commitment to drawing on the latest economic data to inform its monetary policy setting.

“Neutral, then, is not a destination we necessarily reach but more a pole star to guide us,” she said.

“And even then, its location is sufficiently uncertain that we are perhaps better served by paying more attention to the ground as it shifts beneath our feet than to that faraway pole star.”

The neutral interest rate is hotly debated by economists and analysts as it indicates the end of the hiking cycle, which is of interest to any mortgage holders already hurting from sharp increases in their repayments.

AMP Captial economists see the sweet spot around two to 2.5 per cent due to Australia’s high household debt to income levels, meaning households are particularly sensitive to higher interest rates.

“The Australian neutral rate has been on a downtrend for the past 10-15 years, alongside potential GDP growth, interest rates and bond yields,” AMP Capital’s Diana Mousina said.

With the cash rate at 2.6 per cent, AMP economists expect the slightly-above-neutral rate to start putting downward pressure on economic growth and inflation.

Meanwhile, the global growth outlook has been downgraded as the risk of recession grows in several major economies.

The International Monetary Fund has revised its forecasts for 2023 downwards by 0.3 percentage points to 2.6 per cent.

Despite the challenges, Treasurer Jim Chalmers asserts Australia is in a strong position.

He’s in Washington meeting the head of the US central bank, IMF and World Bank bosses, and finance ministers from other nations.

Assistant Treasurer Stephen Jones said the government was being “straight and honest” with the Australian people about the global outlook.

“If our major trading partners look like they’re sliding into recession, then that is going to have an impact on Australia as well,” he told Sky News.

Opposition treasury spokesman Angus Taylor said there was a $500 million “black hole” in the budget.

“What we don’t need to see is Labor realising there is black holes in their forecasts and they try to claw those back with tax increases for Australians,” he told the ABC.


Poppy Johnston
(Australian Associated Press)


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