If Sydney had its own central bank, cash rates would be at 3.75%

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It’s RBA day. And while no one expects the Reserve Bank to move rates today, it seems the move toward higher rates has begun if market pricing and economist expectations are any guide.

But managing the Australian economy and setting the level of interest rates is as much art as science. If it’s not the West and Queensland booming, then it’s New South Wales and Victoria providing the engines of growth.

That means the RBA has to set its cash rate at the level that best approximates a one-size-fits-all level of interest rates for the economy. In some parts of the economy it will be too hot, in others too cold. And, because of a disparate spread of industry and economic activity across the nation, there is potentially no city or region of the economy where the interest rate setting is just right.

It’s one of the reasons why the RBA’s track record of 25 years without a recession is remarkable.

But imagine for a minute that the Pilbara had its own central bank. Or Perth, Adelaide, Sydney, Melbourne, Brisbane and beyond. What would the various cash rates across these varying regions of economic activity look like?

That something the folks at SGS Economics and Planning have done in a new research report looking at economic growth across the nation.

Their analysis shows that during 2015-16, Sydney and Melbourne are at the wheel, driving a combined 67% of GDP growth.

Sydney’s contribution of 38.6% of growth in 2015-16 was the highest since 1991-92, SGS said. Melbourne contributed 28.6% of growth which was its highest percentage on record.

Naturally the corollary of this record strength is that the rest of the nation is struggling. Regional NSW is only just growing, regional Victoria went backwards, Brisbane’s share of growth fell to its lowest level since 2010-11, while Perth’s GDP growth in 2015-16 of 1.6% was its third lowest on record.

This disparity led the researchers to a thought experiment where they imagined “a hypothetical situation where each region has its own central bank setting local interest rates was created”.

Their analysis of where rates should be across the regions, and in Australia’s two biggest cities, perhaps neatly highlights why Sydney and Melbourne property has been going gangbusters.

Sure it might be about investors but it looks like it’s also about rates which are just way too low for the level of economic activity in both cities.

In the case of Sydney, SGS says the Reserve Bank of Sydney’s cash rate should be sitting at 3.75%, while its counterpart in Melbourne had rates lower at 2.25% but still above the current RBA cash rate of 1.5%.

The Northern Territory would also need elevated rates at 3.5%, while the ACT would have rates just a little higher than the RBA at 1.75%.

The rest of the country? Think Europe. SGS says rates should be somewhere between 0.25% and 0.5%.

Here’s the table SGS put together of its hypothetical regional interest rate settings.

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