In an address to participants at the Morgan Stanley Australia Summit on Wednesday (7 June), governor of the Reserve Bank of Australia (RBA) Philip Lowe defended the central bank’s decision to resume monetary policy tightening following a brief pause in April.
The central bank had hinted at winding back its tightening bias amid evidence of sustained disinflation and weakness in aggregate economic activity.
But subsequent evidence of “stickiness” in services inflation both locally and abroad prompted a surprise shift from the RBA, which took a hawkish turn in May and maintained this stance at its latest June board meeting.
Governor Lowe stressed that despite these perceived policy shifts, the RBA remains resolute in its commitment to return inflation to its 2–3 per cent target range.
“There hasn’t been any shift in our tolerance — we want to get inflation back to target within a couple of years, and that hasn’t changed,” he said.
“What has changed over the past couple of months is our assessment of the risks.”
The governor pointed to “upside surprises” on inflation in Australia and overseas, wages growth, and housing prices.
The latest monthly consumer price index (CPI) reported an annualised inflation of 6.8 per cent in April — the first acceleration in 2023.
Wages grew 0.8 per cent over the March quarter and 3.7 per cent in annual terms, with the Fair Work Commission’s recent decision to lift the minimum wage by 5.75 per cent stoking fears of a wage price spiral.
National home values have now increased for three consecutive months, with CoreLogic reporting a 1.2 per cent increase in May preceded by a 0.5 per cent rise in April and a 0.6 per cent increase in March.
“We felt like we couldn’t just sit idly and say, ‘well, this is just all accidental — it’s all just noise’,” governor Lowe said.
“The conclusion we reached was that this represents upside risks to the inflation outlook in Australia.
“We have been prepared to be patient and get inflation back to target but our patience has a limit, and the risks are starting to test these limits.”
In his opening remarks, governor Lowe said the RBA’s decision to lift the cash rate by a further 25 bps in June to 4.1 per cent aimed to support projections of a return to target inflation by mid-2025.
“Yesterday’s decision to increase interest rates again was taken to provide greater confidence that inflation will return to target within a reasonable timeframe,” he said.
“…Services price inflation is proving persistent here and overseas, and the recent data on inflation, wages and housing prices were higher than had been factored into the forecasts.
“Given this shift in risks and the already fairly drawn-out return of inflation to target, the board judged that a further increase in interest rates was warranted.”
However, governor Lowe acknowledged downside pressures, including weaker household spending, higher rents, and mortgage stress.
But he flagged risks of inflation staying “too high for too long”.
“If that happens, expectations will adjust, high inflation will persist, interest rates and unemployment will be higher and the cost-of-living pressures on Australian families will continue,” he said.
Governor Lowe said he continues to expect the economy to navigate the “narrow path” — ensuring improvements in the labour market are sustained while also bringing inflation back to target.
Looking ahead, he said the RBA would monitor developments in the global economy, household spending, growth in unit labour costs, and inflation expectations before determining its next monetary policy move.
The RBA governor’s address was delivered ahead of the release of the latest national accounts data, which revealed Australia’s GDP grew 0.2 per cent over the three months to 31 March 2023, down from 0.6 per cent (revised up) in the December quarter.
The March quarter result fell below market expectations of a 0.3 per cent increase.
In annual terms, GDP grew 2.3 per cent in the 12 months to March 2023, down from 2.8 per cent in the previous quarter and from 3.3 per cent in the previous corresponding period.
GDP per capita also fell, dropping from 0.8 per cent in the 12 months to 31 December 2022 to 0.3 per cent over the year to March 2023.
But according to ANZ senior economist Felicity Emmett, the weaker GDP result would not be enough to dissuade the RBA from future hikes, given the national accounts data reported an increase in unit labour costs (7.9 per cent annualised).
“Given the close relationship between unit labour costs and services inflation, this will add to the RBA’s concerns about returning inflation to the target band ‘within a reasonable time frame’,” Ms Emmett said.
“…This highlights the very narrow path the RBA is now navigating to a soft landing.”
The ANZ economist said she expects further monetary tightening would be likely to be required, with the bank projecting a terminal cash rate of 4.35 per cent.
So the 12 other times they increased haven’t made a difference to inflation?