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Dr Lowe says 4% interest rate by year's end 'unlikely'

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The RBA is not on pre-set interest rate path but the governor has dismissed the likelihood of a 4 per cent official interest rate by year’s end.

The governor of the Reserve Bank of Australia (RBA) has acknowledged that the RBA is not on a pre-set interest rate path and dismissed a 75-basis point (bp) interest rate lift in July, as witnessed this month in the Unites States where inflation rates are much steeper.

Speaking at an event hosted by the American Chamber of Commerce in Australia (AmCham) on Tuesday, Dr Lowe said the July board meeting is likely to reflect on similar considerations discussed in June, but he dismissed the likelihood of rates hitting 4 per cent by the year’s end.

“We’re not a pre-set path, we’re going to look at the data we have each month and at the level of interest rates and the inflation outlook, but I expect that next month we’ll be having the same discussion at our board meeting 25 or 50 bp,” Dr Lowe said.

Asked what he thought of market pundits tipping a rate of 4 per cent in December, Dr Lowe explained that to get there, Australia would have to undergo the sharpest tightening of monetary policy it has ever experienced.

“I’ll leave to others to come to the judgement whether they think that’s reasonable. An increase in interest rates of that magnitude would have a first-order effect on consumption, mortgage payments, confidence and slow the economy quite a lot. So I don’t think it’s particularly likely,” Dr Lowe said, but cautioned that “the market has been a better judge of where interest rates are going than we have over the past few years”.

High inflation to persist

The minutes of the RBA’s June meeting, published on Tuesday, revealed that two options for the size of the cash rate increase were considered at the bank's last rate call for this financial year - raising the cash rate target by 25 or by 50 bps.

“Members noted that both options would leave the cash rate below 1 per cent, which would still be highly stimulatory, and that further increases would be required,” the minutes said.

The main argument for an increase of 50 bps was that the level of interest rates was still very low for an economy with a tight labour market and facing a period of higher inflation.

And on Tuesday, Dr Lowe told the AmCham that inflation would likely remain above the RBA’s target for at least another couple of years as petrol and electricity prices remained high.

“It’s going to be some years I think before inflation is back in the two to three per cent range,” Dr Lowe said.

“But over the next couple of years, it will gradually come down.”

According to the RBA’s forecast, inflation is set to hit 7 per cent by the end of 2022.  

But, despite the headwinds, Dr Lowe said he does not see a recession on the horizon in Australia.

“If the last two years have taught us anything, we can’t rule anything out, but our fundamentals are strong, and the position of the household sector is strong, and firms are wanting to hire people at record rates. That doesn’t feel like the precursor to recession. And interest rates, while they have gone up, are still low,” Dr Lowe said.

Economists are tipping another 50-bp rise in July, taking the cash rate to 1.35 per cent.

Earlier this month, Dr Lowe told the ABC that “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”.