Data Clash! The adjustment of neutral interest rates meets a tightening job market, putting the Australian Reserve Bank in a dilemma.

On Thursday, internal documents released in accordance with the Freedom of Information Act showed that the Reserve Bank of Australia's neutral cash rate model indicates that its estimated value will be "substantially lowered," and the employment market is tighter than previously expected. The downward revision of the estimated value suggests that the RBA's benchmark interest rate may need to be lower than previously expected in order to help the bank achieve its mission. However, the tighter than expected employment market may mean that stricter policies need to be implemented. In March, the RBA's model showed that by mid-2024, the neutral rate would be 2.9%, about 0.7 percentage points lower than the previously estimated 3.6%. This new data has never been disclosed before and is closer to pre-pandemic views, indicating that the extent to which the cash rate is above the neutral level is more severe than previously expected. The RBA will release the documents under the Freedom of Information Act on its website on Friday. The RBA has been cautious about easing policy this year, lagging behind the aggressive pace expected by the financial markets. The neutral rate is the central bank's ideal policy control point, where policy neither stimulates nor suppresses economic activity, and is often used to assess the stance of monetary policy. The RBA believes that the current policy is in a "slightly restrictive" state. RBA officials have repeatedly emphasized the large uncertainties associated with these estimates and stated that these estimates are not the sole basis for policy decisions, as many other factors are considered when formulating policies. Despite the downward revision of the estimated value, an internal research report pointed out that "the gap between the cash rate and the neutral rate is still smaller than the policy rate gap in other economies during peak tightening cycles." Central banks' estimates of the neutral rate The RBA has started cutting interest rates this year, having already lowered borrowing costs three times, with the cash rate currently at 3.6%, the lowest level since April 2023. RBA Governor Michele Bullock stated that "it may require 'a few more rate cuts' to achieve the RBA's latest forecasts on employment and inflation. Economists and the money market expect the RBA to keep rates unchanged at the meeting on September 29-30, and then resume cutting rates in November. Economists predict that the RBA will cut rates again early next year, eventually lowering the rate to 3.1%. Documents show that a study using various labor market indicators estimated the Non-Accelerating Inflation Rate of Unemployment (NAIRU) to be around 4.3% to 4.4%, slightly lower than the RBA's target of 4.5%. NAIRU refers to the lowest unemployment rate that an economy can maintain without causing faster inflation. Data released earlier on Thursday showed that Australia's unemployment rate remained stable at 4.2% in August. Earlier this week, Assistant Governor Sarah Hunter of Australia said that the Australian economy is "very close" to full employment. Following the release of Thursday's employment data, Bloomberg Economics stated that the report is unlikely to prompt the RBA to cut rates this month. Bloomberg Economics economist James McIntyre said, "Although labor demand has cooled significantly, the easing cycle is likely to be a long process." Documents show that a series of models by the RBA indicate that the unemployment rate gap (the difference between the actual unemployment rate and NAIRU) is still in negative territory, approximately between -1% and -0.6%, indicating a very tight labor market. Research suggests that the unemployment rate gap has actually widened slightly compared to May.