Could the next move in interest rates be down?

The next move in interest rates could be down, not up, according to some of Australia's leading economists, as the probability of a recession hits 21 per cent.

A drop to a cash rate of 1 per cent, from the current record low of 1.5 per cent, could be driven by tighter lending restrictions as a result of the banking royal commission and anaemic wage growth, leaving the Reserve Bank in the invidious position of having to use monetary policy to stimulate economic growth.

All but three of the 26 economists in the BusinessDay economic survey expect no move in the cash rate in the rest of 2018.Credit: Louie Douvis

All but three of the 26 economists in the BusinessDay economic survey expect no move in the cash rate in the rest of 2018. Thirteen expect the next move to be up, but not until June 2019, when there  would have been a record 34 months of inaction.

The bank’s cash rate has been steady since RBA governor Philip Lowe’s predecessor, Glenn Stevens, cut it to a record low of 1.5 per cent in his last meeting before handing over. In public comments, Lowe has said the next move will most likely be up, but it will depend on inflation and wage growth, which he expects to improve only gradually.

The survey is Australia's longest-running measure of economic sentiment - over the the past 20 years its forecasts have proved to be more accurate than those of Treasury.

Industry Super chief economist Stephen Anthony said he believed the next move in official interest rates was likely to be down, probably by mid 2019.

"By then, measured prices growth will still likely be below the mid-point of the RBA target range, residential house price declines on the east coast of Australia will probably be double digit and residential housing investment may be falling sharply," he said. "All this will leave Australian households feeling more uncertain about the outlook for jobs and activity."

Industry Super chief economist Stephen Anthony said he believed the next move in official interest rates was likely to be down, probably by mid 2019.Credit: Arsineh Houspian

The majority of economists could not see any movement in rates until at least June next year, but JP Morgan's Sally Auld warned that there was a looming "non-trivial risk" that the RBA might miss the opportunity to start to normalise monetary policy - leaving Australia overexposed to a global shock.

"Indeed, until the RBA is confident that the slowing in credit growth and house prices has not negatively impacted the trajectory of household consumption spending, it will be highly unlikely to consider moving rates higher and consequently, rates are likely to be on hold for a protracted period," she said.

"This leaves the RBA at the mercy of global developments, and potentially, very vulnerable to the next global downturn. Were such an event to be realised, it is highly probable that the next move in rates in Australia is down."

Commonwealth Bank economist Michael Blythe said while he expected rates to go up in late 2019, stubbornly low inflation and high household debt could curtail that.

"If the royal commission prompts much tighter credit conditions, then rates may not be raised until 2020 or they may even be cut," he said.

Stephen Koukoulas from Market Economics shared Mr Blythe's sentiments and argued the RBA had been overly optimistic in its forecasts.

"The RBA will cut interest rates once it changes its 'glass half full' denial of key aspects of the economy that remain well below par," he said.

Others are more optimistic. University of Tasmania economist Saul Eslake said he believed inflation would start to move back into the central bank's target range of 2-3 per cent by May next year.

"It should feel sufficiently confident that economic growth is 'around trend' and that labour market slack is decreasing; and that wages growth should have picked up a little bit," he said.

Despite the general cautious optimism throughout the survey, the economists increased the prospects of a recession in the next year from 15 per cent to 21 per cent.

The concerns have been driven by IMF and OECD expectations that world growth will turn down as the US scrambles to fund the Trump tax cuts and historically high levels of debt in China as it moves from a manufacturing to a consumption-driven economy.

Overall, only two of the panellists assigned a negligible probability to a recession within the next two years: the Melbourne Institute’s Guay Lim and JP Morgan’s Auld.

The panel expects modest economic growth of 2.8 per cent in 2018-19, a touch below the Treasury’s forecast of 3 per cent.