Governor of the Reserve Bank of Australia (RBA) Philip Lowe has cautioned that interest rates will continue to rise in order to help stem rising inflation, which he predicted will peak at 7 per cent by the end of the year.
Speaking to the ABC earlier this week, Dr Lowe said “it’s reasonable that the cash rate gets to 2.5 per cent at some point”.
“I say that because the midpoint of our inflation target is 2.5 per cent. So an interest rate of 2.5 per cent in inflation-adjusted terms is a real interest rate of zero, which in historical terms is a very low number. And I would expect that over time, we want an average inflation-adjusted interest rate to be more than zero,” Dr Lowe explained.
“How fast we get to 2.5 per cent, and indeed whether we get to 2.5 per cent, is going to be determined by events”.
And inflation is certainly a cause for worry for the RBA, which earlier predicted it to peak at around 6 per cent.
However, Dr Lowe now expects inflation to get to 7 per cent, driven partly by external factors such as the war in Ukraine and global supply issues.
“That’s a very high number and we need to be able to chart a course back to 2 to 3 per cent inflation.”
Questioned about the RBA’s earlier vow of patience, which saw it time and time again, reiterate its commitment to keep rates steady by 2024, Dr Lowe admitted that the economy “didn’t evolve as we expected”, adding that “it’s been much more resilient and inflation has been higher”.
“And we needed to respond to that”.
“I understand that people will make borrowing decisions based on our communication, and people took out loans that they may not have otherwise taken out,” he continued.
“Over the past couple of years, people have put away an extra $250 billion – it’s a lot of money, and the saving rate is still high, and the number of people who’ve fallen behind in their mortgages is actually declining, not rising”.
At the end of the day, he said, the RBA’s responsibility is a national one.
“We want to make sure that inflation is low and stable, the country gets to full employment, the financial stability of the country is preserved, the country has high-quality banknotes, and we provide high-quality banking services to the government. So that’s our big picture”.
Dr Lowe, however, conceded that “it’s unclear at the moment how far interest rates will need to go up” to get inflation into the central bank’s target band.
“The peak will be in the December quarter this year and by the time we get into the second half of next year, inflation will clearly be coming down. But in the first quarter, we’ll see lower rates of headline inflation”.
Overall, Dr Lowe expects the Australian economy to continue to grow “pretty strongly” over the next six to 12 months.
“There’s still a bounce back from all the COVID restrictions. People are spending in a way that they weren’t able to do last year. People have got their savings that I’ve talked about to draw on and the current rate of saving is still quite high. So it’s quite plausible that saving patterns return to where they were before, so even if income growth is a bit weaker, people have the financial capacity to keep spending”.
Questioned about a potential misalignment between the bank’s monetary policy and the government’s fiscal policy, he said he was “not particularly concerned”.
“I’ve already had a couple of meetings with the new Treasurer. I know he is as committed as I am to bringing inflation back to the 2 to 3 per cent range. So I think over the next little while, there’ll be close alignment between fiscal and monetary policy. I have no concerns there,” Dr Lowe said.
The issue that he thinks is more important is how as a society “we’re going to pay for the increasing demands on the public purse”.
There are three options he said.
“We can make sure the economy grows very strongly, so that the pie is bigger and so there is more funding for everything. That’s the best option.
“Another option is to cut back in some other areas, but that’s pretty hard, isn’t it?
“And the third option is to raise more revenue through higher taxes and that comes with complications as well,” Dr Lowe explained.
“In the short run, I’m not so much worried about the lack of alignment between fiscal and monetary policy – that can be worked out,” he concluded.
Earlier this month, the RBA surprised markets with a 50-basis point hike pushing the rate up from 0.35 per cent to 0.85 per cent.
The big four banks now expect rates to pierce 2 per cent by the end of the year.
