Australia CB to Shrug Off IMF Call to Slash Interest Rates

The Reserve Bank of Australia is expected to resist urging from International Monetary Fund for it to cut official interest rates “significantly” over the next few quarters, slashing the cash rate to 0.75%, from its present level of 1.5%.

As part of its latest review of Australia, the IMF published a “Selected Issues” paper, that argued the RBA now belatedly faces some of the same challenges that other central banks have battled since the global financial crisis, with sluggish growth raising the risk of “dark corners”, where the economy becomes stuck in a low inflation and low growth trap, news outlets reported.

To counteract this risk, the IMF says the RBA should respond with a “low for longer” interest rate policy to avoid the risk of the economy suffering a prolonged period of economic slack. “Under this case, the policy rate would be cut significantly over a few quarters, falling to 0.75% before it gradually increases,” the fund says.

The IMF adds this would close the output gap much more quickly and return the inflation rate to the 2 to 3% target range “shortly over the next few quarters”.

But economists argue that the RBA is unlikely to take any notice of the IMF’s advice. In the first place, the RBA clearly believes there is a relatively low prospect of the Australia economy becoming stuck in a “dark corner”.

In its February statement on monetary policy, the central bank said GDP growth “is forecast to increase to 2.5 to 3.5% in late 2017, and to be above potential for most of the forecast period”.

The RBA is also expecting a steady pick-up in inflation, with underlying inflation forecast to reach 1.75% in June this year, and to climb to 2 to 3% in June 2019.

Economists also point out that the IMF’s economic model puts a much heavier weight on the role of inflationary expectations than the model used by the RBA. 

In particular, they note that the RBA does not share the IMF’s view that a slight under-shooting of the inflation target risks triggering a downward spiral that would drag both inflationary expectations, and inflation, sharply lower.

What’s more, economists say the RBA will be deeply wary of fuelling asset price bubbles—particularly in the Sydney and Melbourne property markets—with a spate of further interest rate cuts.