Restraint urged with RBA’s 3.5% neutral rate call

Excitement in the markets around the latest Reserve Bank revelations is premature, according to one leading economist

Restraint urged with RBA’s 3.5% neutral rate call



While the markets and the Australian dollar reacted strongly to the Reserve Bank of Australia’s (RBA’s) proclamation on Tuesday (18 July) that the “neutral nominal cash rate” should equate to 3.5%, one economist has called for caution.

The day’s reactions showed a bit too much excitement, Savanth Sebastian, senior economist at CommSec, told Australian Broker.

“The important thing is not to get too far ahead of ourselves. We have to realise that the Reserve Bank has made mention of the neutral, natural setting for the economy several times over the last couple of years.”

Putting the announcement in context, he said it would take the RBA a number of years to reach this neutral setting.

“It’s essentially just starting the process and the discussion to look at where rates need to go over the medium-term.”

For the banks, this highlights that rates will eventually lift over the longer-term which will support the financial sector in general, he said.

“The one thing you don’t want to see over the medium term is that rates rise too quickly which will create some serious issues for the housing sector. That could be detrimental to the banks.”

There were no definitive signs in Tuesday’s RBA Board meeting minutes that suggest the cash rate will increase anytime this year, he said.

“I think they’re just starting the discussion process while giving themselves the option and trying to get the message out there that higher rates are coming.”

The prospect of higher rates coupled with prudential measures to tighten lending could sap the property market and reduce current levels of high demand, he said.

Mortgage stress will also be a key factor that the RBA will consider when choosing to raise the cash rate in future.

“They’re not going to go out and raise rates without thinking about the repercussions on household debt and mortgage stress. That’s one of the key risks to the economy and they’ll watch that space very closely when lifting rates. What they’d want to see is a solid lift in wage growth and decent lift in overall inflation before they pull the trigger on rate hikes.”

CommSec predicts the first rate hikes will come next year rather than later this year, he said.

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