This Interest Rate Probability Model From ANZ Has A Good Track Record, And Shows Just A 10% Of An RBA Cut

The recent run of weak economic data in Australia has convinced interest rate traders that there is a chance that the RBA will cut rates in the first quarter of 2015.

This is a big swing from where expectations were just a month ago when the market was thinking no change and then rates moving higher from early 2015.

The way the market measures this move in futures implies a more than 50% chance that the RBA will cut.

Not so, according to ANZ economists who say the chance is less than 10% using their “modelling based on leading indicators of the cash rate.”

With varying lags the ANZ model appears extremely robust and includes as inputs the level of the cash rate, interest rate spread between long and short interest rates in Australia, retail sales, the Westpac Sentiment sub-series on family finances, and building approvals.

These indicators are then combined into a probability model which appears to have a fairly solid track record based on the evidence presented in the ANZ Economic team’s note.

While the ANZ notes the challenging time faced by the Australian economy at the moment it’s own fundamental view accords with the model.

The low probability that the model ascribes to a potential interest rate cut is consistent with our view of how the economy is evolving. While momentum in the domestic economy has softened recently, most indicators are continuing to point to a gradual improvement in the non-mining sectors of the economy.

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