RBA Paper Sees Neutral Cash Rate Falling to About 1%

--Housing Market 'Particularly Important' For RBA Policy Transmission

--Lower Cash Rate Tends to Lower AUD, But Effect Small

By Sophia Rodrigues

     SYDNEY (MNI) - The Reserve Bank of Australia's neutral official cash rate

has fallen by around 150 basis points since 2007 to about 1% now, with most of

the decline due to a fall in potential output growth, heightened risk aversion

and a widening in spreads, a paper published by the Reserve Bank of Australia

said.

     The paper estimates the range of the neutral rate to be very narrow, 

between 0.5% and 1.5%. This would mean the current cash rate of 1.5% is at the

upper end of the neutral range, or slightly restrictive.

     The paper is one of nine articles in the RBA's quarterly bulletin published

Thursday.

     This paper was likely discussed in the RBA's July board meeting and that

discussion was included in the minutes published that month. The discussion of

the neutral interest rate in the meeting led to speculation that the RBA has

begun thinking of monetary policy normalization but this was dismissed by senior

officials in their speeches and comments later.

     In the early 1990s the neutral cash rate was estimated at 3%, so the fall

since then is around 200 basis points, with 50 basis points of that decline due

to fall in potential output growth.

     According to paper, changes in spreads should have a one-for-one effect on

the neutral interest rate and in Australia the spread between market interest

rates and the cash rate have widened by 100 basis points or more.

     "Most of the increase in risk aversion and widening in spreads occurred

around the time of the global financial crisis. These developments are therefore

the most plausible explanation for the large fall in the neutral interest rate

that occurred at this time," the paper said.

     The size of the estimated fall in Australia's neutral interest rate is

similar to that of Canada and the United Kingdom, but smaller than the estimated

declines in the United States and the euro area, the paper said. However, given

the uncertainty inherent in these estimates, the paper's authors cautioned

against reading too much into this divergence.

     A separate RBA paper discussed how monetary policy transmission works in

Australia -- the stages of transmission and the channels through which it

occurs.

     "The effects of monetary policy are hard to quantify, though the housing

market seems particularly important to the transmission process in Australia,"

the paper said.

     A lower cash rate stimulates household spending and housing investment,

partly through increasing the wealth and cash flow of households, the paper

said.

     A lower cash rate also tends to result in a depreciation of the exchange

rate, the paper said, but added that the effect of interest rates on the

exchange rate is relatively small. An unexpected 25 basis point decrease in the

cash rate is estimated to lead to a 0.25% to 0.5% depreciation of the exchange

rate, it said.

     A third paper discussed how conditions facing the resources sector appear

to be stabilizing following the adjustment after the boom.

     The paper said that employment in the resources and resources-exposed

sectors is stabilizing, and that further gains in productivity are difficult to

achieve in the short term. 

     "However, there is likely to be downward pressure on employment in the

resources sector over the longer term from the automation of mining machinery

and equipment," it said.

     The paper noted in particular that completion of the remaining liquefied

natural gas (LNG) projects is not expected to add much to employment because

they require significantly fewer operational employees than iron ore and coal

projects. 

     Estimates based on company reports and liaison suggest that combined

operational employment at LNG projects will stabilize at a few thousand people,

compared with tens of thousands involved in iron ore and coal operations, the

paper said. 

     "Over the long term, the experience of the mature LNG projects suggests

that the new LNG projects are likely to be able to expand production through

process improvements without increasing employment," it said.

     Another paper discussed the rising share of part-time employment in the

economy and its importance in assessing wage and price pressures in the economy.

     The paper noted that while the majority of part-time workers appear to be

working part-time hours voluntarily, there is a pool of part-time workers who

want to, and can, work additional hours. 

     "These workers represent additional spare capacity in the labor market that

should be considered when assessing wage and price pressures in the economy,"

the paper said.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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