The Reserve Bank (RBA) governor, Philip Lowe, has warned Aussies that more interest rate hikes are on the way.
Speaking to the American Chamber of Commerce in Australia, Lowe pledged not to repeat the costly mistakes of the 1970s stagflationary period, and to “do what is necessary” to squash inflation before it becomes entrenched in the national psyche.
Dr Lowe also said a review into the bank’s Covid-era policy of pinning interest rates at 0.1 per cent out to three years had found the “disorderly” end to the program late last year had “caused some reputational damage to the bank”.
Dr Lowe warned that:
“As we chart our way back to 2 to 3 per cent inflation, Australians should be prepared for more interest rate increases”.
“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.”
Stagflation
Fears of stagflation - low growth and high and rising unemployment and inflation have smashed global financial markets.
Dr Lowe said:
“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."
So it is important that we chart our way back to an inflation rate in the 2 to 3 per cent target range.
We do not need to, nor can we, get there immediately. Australia has long had a flexible medium-term inflation target, which, by design, can accommodate deviations of inflation from target.
For a number of years inflation was below target and now it is above.
What is important here is that we chart a credible path back to an inflation rate of 2 to 3 per cent.”
Inflation to peak at year end
Dr Lowe repeated that he now expected inflation would peak at 7 per cent around the end of this year.
“Following this, by early next year, we expect that inflation will begin to decline ...assisted by a trio of factors: easing Covid-19 era supply chain disruptions; the drag on demand from the global monetary policy tightening; and the fact that some of the price gains are unlikely to be maintained.
More rate rises to come
The RBA is expected to lift rates by a further 0.5% or even 0.75% when the board next meets on July 5, after delivering back-to-back rate hikes in May and June which took the key policy rate from a record low 0.1 per cent to 0.85 per cent.
Lowe said inflationary pressures - ie the rising cost of living - were growing at a much faster pace than expected and the board had to act.
“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.
“So, it is important that we chart our way back to an inflation rate in the 2-3 per cent target range.
We do not need to, nor can we, get there immediately.”
He said it would be easier for the bank to navigate the path of getting interest rates back in the target range if the psychology of Australians “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.
Achieving that balance is not straightforward and there are risks involved, but higher interest rates will lessen the current inflationary pressures”.
Dr Lowe offered little guidance as to how far rates would eventually have to rise but has previously flagged that 2.5 per cent could be considered a “neutral” rate.
In his speech, Dr Lowe said “powerful global factors” were working to drive inflation higher across the world – not least a 28 per cent increase in global oil prices since February thanks to Russia’s invasion of Ukraine.
A 37 per cent jump in petrol prices over the past year has added 1 percentage point to inflation – which as at March was 5.1 per cent.
But while it was impossible to “insulate” ourselves from this global trend, Dr Lowe said inflation was increasingly homegrown, as shown in an extraordinarily tight labour market and a construction sector operating at near capacity.
“Reflecting this, the share of items in the CPI basket with annualised price increases of more than 3 per cent is at the highest level since 1990.”
RBA puts 3.5pc lid on wages
Governor Philip Lowe has sought to put a lid on wages growth of about 3.5 per cent and warned regular pay rises of 4 to 5 per cent risked entrenching higher inflation.
Dr Lowe flagged the need of real wage cuts, saying annual rises in the mid-threes was a good “anchoring point” for employers and unions, even while inflation was forecast to reach about 7 per cent by year’s end.
His comments come after the Fair Work Commission last week lifted the minimum wage for 184,000 workers by 5.2 per cent, and 4.6 per cent for about 2.6 million workers on higher awards.
And while pay rises above 3.5 per cent “for a short period of time” were possible, he warned a wage price spiral would force aggressive rate rises that slow the economy and push unemployment higher.
“If wage increases become common in the 4–5 per cent range, then it is going to be harder to return inflation to 2.5 per cent,”
