For Australian central bank watchers, it seems no one is neutral on where neutral actually is.

Economists and money markets are betting the point at which interest rates are neither stimulative or restraining is lower than the central bank’s estimate of about 3.5 percent. And if markets and analysts are right, that means there’s less stimulus in the economy than the RBA thinks, even before factoring in the tightening effect of a rampaging currency.

While the board will likely leave its official cash rate unchanged at a record-low 1.5 percent Tuesday, the release of the neutral estimate almost two weeks ago sent the Aussie dollar soaring in the belief policy makers were laying the ground to tighten. It was only after Deputy Governor Guy Debelle and Governor Philip Lowe used speeches to dismiss the significance of the rate’s inclusion in the July minutes that the frenzy briefly eased.

The RBA estimated the neutral cash rate at 3.5 percent: equivalent to a real rate of 1 percent plus the 2.5 percent midpoint of its inflation target. But it’s notable that CPI hasn’t reached that midpoint since mid-2014; indeed five-year inflation swaps show 2 percent is a more realistic average for inflation, which would provide a neutral rate of 3 percent. The median of 10 economists surveyed by Bloomberg was similarly 3 percent.

The lower neutral estimate suggests that while policy is still loose in Australia, it’s not as loose as a 3.5 percent rate would imply. Meanwhile, the Aussie dollar has jumped more than 7 percent on a trade-weighted basis since June 1. Paul Bloxham, chief economist for Australia at HSBC Holdings Plc, estimates a 5 percent increase in the TWI is equivalent to a quarter-point rate increase.

Australia’s headline inflation came in at a lower-than-expected 1.9 percent last quarter, missing the bottom of the central bank’s target, which also shows the cash rate is less stimulatory on a real basis. Meanwhile, the spiraling currency is likely to cut the cost of imports, further curbing consumer-price growth.

And for borrowers, the record-low cash rate doesn’t reflect reality. Following the introduction of lending curbs and other measures by regulators to cool the housing market and investor lending in particular, the gap between the average mortgage rate and the official cash rate has widened to 3.5 percentage points.

Source:
courtesy of BLOOMBERG

by Michael Heath

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