Addressing the Anika Foundation and Australian Business Economists, governor of the Reserve Bank of Australia (RBA), Philip Lowe, hinted that the RBA does not intend to pivot to a slower pace of monetary tightening just yet.
Dr Lowe said that further increases in interest rates will be required over the months ahead, but acknowledged once again that the board “is not in a pre-set path”.
The governor did, however, hint that he is acutely aware of the response lag.
“We are conscious that there are lags in the operation of monetary policy and that interest rates have increased very quickly. And we recognise that, all else equal, the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises,” Dr Lowe said.
“But how high interest rates need to go and how quickly we get there will be guided by the incoming data and the evolving outlook for inflation and the labour market,” he explained.
Since May, the RBA has raised the cash rate by a cumulative 2.25 percentage points, including a 0.50 per cent rise earlier this week.
“This increase in interest rates — from what was a historically low level — is to ensure that the current period of high inflation is only temporary and that a more sustainable balance between demand and supply is established,” Dr Lowe said.
Terming high inflation “a scourge”, Dr Lowe stressed it is “important” that this current surge in inflation is only temporary and that “we once again return to the 2 to 3 per cent range”.
“The board is committed to the return of inflation to target. It is seeking to do this in a way that keeps the economy on an even keel; it is possible to achieve this, but the path here is a narrow one and it is clouded in uncertainty,” the governor said.
He highlighted three sources of this uncertainty.
The first, he said, is the global economic environment.
“Some slowing in the global economy will help bring inflation down, but a sharp slowing would make the job of delivering a soft landing here in Australia much harder,” Dr Lowe acknowledged.
The second source of uncertainty is domestic in nature, he said, and that is how inflation psychology in Australia adjusts to the period of high inflation.
“If workers and businesses come to expect higher inflation, and wages growth and price-setting behaviour adjusts accordingly, the task of navigating that narrow path will be very difficult, if not impossible,” the governor said.
“A shift higher in inflation expectations will require higher interest rates. In time, that would mean a sharper slowing of the economy. It is in our national interest that we avoid this,” he assured.
The third source of uncertainty is how households respond to higher interest rates.
According to the governor, while the full effects of the rapid increase in rates is yet to be felt by households, “it is still difficult to know” how several factors will balance out. These factors include “large financial buffers” “many households” have built up, and the extent to which “many” households are benefiting from the strong labour market.
“We are paying close attention to these various uncertainties”, Dr Lowe said.
Lowe says ‘no intention to resign’
Following calls by the Greens this week for Dr Lowe to be sacked, the governor assured he has “no intention to resign”.
The resignation talk was sparked by the RBA’s latest rate increase with the Green’s Nick McKim arguing Dr Lowe has broken a pledge to the Australian people. Namely, last year the governor insisted that rates wouldn’t go up until at least 2024, but in May the central bank began its fastest tightening cycle on record.
“Last year Dr Lowe effectively told Australians interest rates wouldn’t go up until 2024, he’s now presiding over a Reserve Bank that’s just putting interest rates up through the roof,” Dr McKim told Channel Nine earlier this week.
In his address on Thursday, Dr Lowe explained that the bank is simply reacting to an “unexpected” surge in inflation, which he partially blamed on Russia’s invasion of Ukraine and various problems in the production of energy around the world.
“The RBA has plenty of company in not predicting this lift in inflation,” Dr Lowe said.
“Analysis by the European Central Bank suggests that around three-quarters of the surprise in inflation in the euro area reflects unexpected developments in the markets for oil, gas and electricity,” he continued.
“In the United Kingdom, the Bank of England estimates that higher energy prices will directly boost CPI inflation by 6½ percentage points this year. And in Australia, the price of petrol at the bowser increased by 32 per cent over the past year. The direct effect of this alone has been to add 1.2 percentage points to Australia’s CPI inflation, and on top of this, there are second-round effects of higher fuel prices.”
Dr Lowe admitted that “forecasters” at the RBA “certainly” did some soul-searching following last year’s misses, adding that “it is important that we learn from this and improve our understanding of the inflation process”.
