RBA Governor back in spin mode

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by Glenn Dyer

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Tuesday’s speech from RBA governor Philip Lowe warning that interest rates are going to have to rise to try and put a lid on rising inflation was nothing really different than his comments a week ago on the ABC’s 7.30 program with Leigh Sales.

Speaking to the American Chamber of Commerce in Sydney on Tuesday morning he said the bank was committed to doing what was required to bring inflation back to within its 2% to 3% target band.

There was nothing exceptional in that – it has been RBA policy for decades.

What is new is that he thought it necessary to follow up his surprise 7.30 appearance with a second public appearance in a week.

The speech was made a couple of hours before the release of the minutes of the RBA June monetary policy meeting (the one where rates were lifted 0.50%).

In some respects, the contents of his speech can be read as an updated version of this minutes.

He did say he didn’t see interest rates (the cash rate) hitting 4% as some of the pricing in bond markets has been suggesting.

But he did remind people to keep an eye on markets (as if they didn’t already).

He did make it quite apparent that big pay rises were not going to make the RBA happy or help keep rates rises to a minimum. Asking for a rate rise with a 3% in front of it would be preferable.

Lowe said home buyers, who took on record levels of debt through the Covid recession, said they should be prepared for more interest rate pain.

“As we chart our way back to 2 to 3 per cent inflation, Australians should be prepared for more interest rate increases,” he said.

“The level of interest rates is still very low for an economy with low unemployment and that is experiencing high inflation.”

“High inflation damages the economy, reduces the purchasing power of people’s incomes and devalues people’s savings. It is also regressive, hurting most those who are least well equipped to protect themselves,” Dr Lowe pointed out.

“I want to emphasise though that we are not on a pre-set path. How fast we increase interest rates, and how far we need to go, will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market,” he said.

He again pointed to inflationary expectations, saying the path to lower rates will be easier to navigate if the inflation psychology in Australia does not shift too much.

“A lesson from the 1970s is that if an inflation shock shifts people’s expectations about the ongoing rate of inflation, it becomes harder to reverse.

“Applying this lesson to today, it is important that the higher rate of inflation this year does not feed through into ongoing inflation expectations. If it did, the period of higher inflation would persist and it would be more costly to reverse.

“To date, medium-term inflation expectations have been well anchored at around 2 to 3 per cent, suggesting that people believe we will get back to target. We want to do what we can to make sure this remains the case.

“Higher interest rates have a role to play here, by helping ensure that spending grows broadly in line with the economy’s capacity to produce goods and services.

“Higher interest rates can also directly affect expectations by demonstrating the commitment of the RBA to return inflation to target.

“The level of interest rates is still very low for an economy with low unemployment and that is experiencing high inflation.

Dr Lowe said the central bank continue to watch the global economy closely, while it will be labour costs (remember to temper your pay demands) and consumer spending that will be two very closely monitored domestic indicators.

The bank will be watching for signs of and how both are responding to rising interest rates.

Here the bank will want to see a start to rising jobless numbers (but Lowe didn’t say that directly), weaker consumer spending as evidenced by sluggish retail sales growth and signs of a slowing in the push for higher wages.

“The recent news on household spending has been broadly positive, with spending bouncing back following the Omicron setback.

“Household balance sheets are generally in good shape, with households overall having accumulated more than $200 billion in additional savings during the pandemic.

“Furthermore, the current rate of saving out of income remains materially higher than it was before the pandemic, so there is a degree of flexibility in many household budgets.

“It is also relevant that strong employment growth is continuing and that there are many job opportunities at the moment.

“However, on the other side of the ledger, many households have not previously experienced a period of rising interest rates.

“Households are also experiencing a decline in real incomes because of the higher inflation and some of the large gains in housing prices over recent years are being unwound.

“Given these various considerations, we will be watching household spending carefully as we chart our way back to 2 to 3 per cent inflation.”

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