Thursday, December 09, 2010

It's the vibe of the thing: How the Reserve sets rates

Lowe's full speech is below

Ever wondered about the worth of official forecasts?

The Reserve Bank does too, and refuses to take them literally.

In a candid assessment of limitations of expert predictions delivered to a Sydney conference of business economists last night assistant governor Philip Lowe said they weren't that important in driving interest rate decisions.

What mattered more was analysis and a "storyline".

"The board’s decisions are not driven in a mechanical fashion by the forecasts," he told the forecasters. "Both the Bank staff and the Board are very conscious of the limitations of numerical forecasts."

"What is often more useful is the analysis and storyline that support the numerical forecasts."

Although the Bank aimed to keep inflation between 2 and 3 per cent it had never felt "the edges of the target were like an electric fence"...

Inflation had been outside the target band more often than it had been inside it but that was fine because the Bank also has to consider what's best for the economy.

At times it might be best to push up interest rates even if the target didn't require it if asset prices were rising quickly or there was too much borrowing.

While the Bank made use of a computer model and the judgment of its 50 or so economists it also relied heavily on"liaison"meetings with business figures - about 100 per month. On several occasions it has learnt things from those meetings it wouldn't have found out in any other way.

The forecasting conference received an update of forecasts from a group of 18 leading business economists including the chief forecasters for each of the big banks and foreign institutions such as Deutsche Bank and JP Morgan.

Their central forecast is for the Reserve Bank to leave its cash rates on hold until mid next year, after which it will push up three times in quick succession and then once more in 2012. But some forecasters expect just one rate rise next year and some as many as four.

On balance the Australian dollar is expected to remain at about $US1 until mid next year before sliding to 93 US cents by December and 87 by December 2012. But some expect little slippage predicting 98 cents by next December.

They expect solid growth of 3.5 per cent per year led by very strong investment growth of 13 per cent and 11 per cent. Inflation will climb at the very top of the Reserve Bank's target band setting at 3 per cent with unemployment settling at 4.8 per cent. The ASX 200 share index will climb from 4670 to 5300 by next December and 5500 by December 2012.

"There was a lot of agreement," said one of the forecasters, the ANZ's Warren Hogan. "It has me worried. It might mean things turn out completely different."


Solid growth 3.5% 2011 3.5% 2012

Strong investment 13% 2011 11% 2012

High inflation 3.0% 2011 3.0% 2012

Low unemployment 4.8% 2011 4.8% 2012

RBA cash rate 5.50% 2011 5.75% 2012

Australian dollar US 0.93 2011 US 0.87 2012

ASX 200 share index up 13% 2011 up 4% 2012

Australian Business Economists executive committee

ABE Executive Forecasts


Forecasting in an Uncertain World - 8 Dec 2010

Related Posts

. Are Some Forecasters Really Better Than Others? Oh my

. "This is where it all happens? Now, where does everyone sit?"

. The People's Governor unwinds for the cameras