Cash rate should stay at historic low

Interest rates are expected to remain at the historically low rate of 0.1 per cent for the February round despite rising inflation and expectations of a future rise in interest rates, according to the RBA Shadow Board at The Australian National University (ANU).

While inflation for the December quarter rose 0.5 per cent to 3.5 per cent, the Shadow Board says while the rise in inflation is higher than market estimates, its verdict on an appropriate interest rates is, once again, unchanged.

"We have little doubt --94 per cent confident - that keeping the cash rate at the historically low rate of 0.1 per cent is the appropriate policy for the February round," said Shadow RBA Chair Dr Timo Henckel.

"While we continue to be very confident that the overnight interest rate should remain steady this round, the Shadow Board's conviction -- in light of recent inflation data -- has weakened slightly.

"It attaches a 94 per cent probability that 'no change' is the appropriate policy, down from 100 per cent, and a six per cent probability that an increase is appropriate, up from zero per cent."

The official cash rate target has now been at the historic level of 0.1 per cent for 14 months.

According to the Shadow Board, other indicators such as the labour market continue to improve, as does the most recent GDP growth data.

However, this is balanced by a retreat in the value of the Australian dollar after a short-lived rally in December, high energy prices and continual risks to the global economy posed by the COVID-19 variants.

"Consensus is now growing that the Federal Reserve in the US will start tightening monetary policy as early as March 2022, adding pressure on other central banks, including the RBA, to follow suit," Dr Henckel said.

He said the probabilities for interest rate rises in the longer term has increased slightly.

"Six months out, the confidence that the cash rate should remain at 0.1 per cent has softened further, from 75 per cent in December to 59 per cent in the current round.

"The probability attached to the appropriateness of an interest rate decrease remains unchanged at zero per cent, while the probability attached to a required increase rose from 25 per cent to 41 per cent.

"One year out, the Shadow Board members' confidence that the cash rate should be held steady also fell, from 50 per cent in December to 39 per cent in this round," Dr Henckel said.

Read the full commentary online.