RBA hints at slower pace of interest rate hikes as it fights rampant inflation

Philip Lowe, RBA Governor, has defended his own position, hinted that the pace of interest rate hikes may slow, and called into question one of the bedrocks of Australian monetary policy over the past 30 years.

Phone with RBA's inflation website page loaded.
RBA Governor Philip Lowe has defended his handling of monetary policy over the past year. (Image source: Shutterstock.com)

In a wide-ranging speech with implications for every Australian household, Reserve Bank Governor Philip Lowe refused to stand down, hinted the RBA could soon take its foot off the interest rates accelerator and questioned the validity of the bank’s long-held 2-3 per cent inflation target.

Updating their forecasts in the wake of Thursday’s speech (8 September) in Sydney, the major banks are tipping rates to eventually peak at either 2.85 per cent (CBA, NAB) or 3.35 per cent (ANZ, Westpac).

ANZ is now the only one of the big four banks expecting the RBA to slug borrowers with a double hike in October instead of the standard 0.25 per cent increment.

“The case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises,” Mr Lowe said in his Inflation and the Monetary Policy Framework annual speech to the Anika Foundation.

Describing the lift in inflation, and projections of it hitting 7.75 per cent, as a “very, very big surprise”, he said it was a bad forecasting miss driven by a big lift in energy prices stemming from Russia’s invasion of Ukraine.

“The RBA has plenty of company in not predicting this lift in inflation.

“Some forecasters were certainly expecting higher inflation than we were, but the magnitude of the pick-up in inflation has taken everybody by surprise.”

“Forecast misses of this scale should lead to soul-searching by forecasters and they certainly have at the RBA (and) it is important we learn from this and improve our understanding of the inflation process.”

Consumer Price Inflation

Mr Lowe said he would not quit, as the bank’s successes in boosting employment among women and young people had bolstered the country’s economy despite the effects of the pandemic.

Greens treasury spokesman Nick McKim and Nationals senator Matt Canavan had earlier demanded the governor resign over his handling of monetary policy.

“I can assure you I have no plans to resign,” he said.

“The economy is so much better than what people thought was going to be the case.

“Interest rates are higher, and I know people don’t like that, but you should be welcoming a stronger economy.”

Fuelling inflation

On Tuesday, the RBA lifted rates by 50 basis points for the fourth month in a row, stretching household budgets and suppressing the property market.

As of Monday (12 September), 18 banks had announced their variable mortgage rate rises, including all big four banks lifting rates by 0.50 per cent for new and existing customers.

Mr Lowe attributed much of the inflation shock to events that were difficult to foresee.

Graph 2: Trimmed Mean Inflation Forecasts

“One starting point for understanding the unexpected surge in inflation is the big lift in energy prices stemming from Russia's invasion of Ukraine and various problems in the production of energy around the world.

“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.

“In the United Kingdom, the Bank of England estimates that higher energy prices will directly boost CPI inflation by 6.5 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,” he said.

Moving target

The RBA’s primary goal since the early 1990s has been to contain inflation within a 2-3 per cent inflation target, but Mr Lowe said this bedrock of economic policy may need to change.

“Many other countries have chosen 2 per cent as their nominal anchor.

“As part of the (current) review, it is worth examining the arguments for and against a change to the nominal anchor,” he said.

But the RBA Governor also made a case for keeping it.

“Any monetary policy regime is likely to face challenges in today's changing world,” he said.

“Our economies are adjusting to the ageing of the population, the emergence of new digital technologies, climate change, slower productivity growth and a less interconnected global economy.

“These changes are affecting the dynamics of inflation and will continue to do so (and) as our economy continues to adapt, the strong nominal anchor and the flexibility provided by flexible inflation targeting will both be very helpful.”

With inflation at 6.3 per cent, inflation would still be the sole focus of the RBA.

RateCity.com.au Research Director, Sally Tindall, said double hikes may be coming to an end but the trajectory for the cash rate is still up.

“While we’re likely to be well over the halfway mark, there could still be another one percentage point of hikes to come, in order to get inflation back under control, potentially even more,” she said.

“Governor Lowe is prepared to do what it takes to get the inflation genie back in the bottle because the consequences of not reining it could have significant, more widespread problems.

“The remainder of the year is going to be incredibly tough for many families with a mortgage as both inflation and interest rates ramp up in the lead up to Christmas.”

Three unknowns

Mr Lowe said the path towards inflation below 3 per cent was a narrow one clouded in uncertainty.

First was the global economy, with the US Federal Reserve locked into a period tight monetary policy and limited economic growth, China’s economy being held back in part by its approach to Covid, and an energy crisis in Europe.

“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.”

The second, he said, was a shift in inflation psychology.

“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,” Mr Lowe said.

The third source of uncertainty is how households respond to higher interest rates, with the full effects of rapidly rising rates still playing out.

“Household budgets are also under pressure from higher inflation, and housing prices are declining after large gains (but) on the other hand, many households have built up large financial buffers, including through offset accounts, and the household saving rate remains higher than it was before the pandemic.

“It is still difficult to know how all of these factors will balance out, but recent data continues to suggest resilience in consumer spending.”

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