Australia Watching World Economy, Wages for Rate Path, Lowe Says

Australia’s central bank will pay “close attention” to household spending, wage and price setting behavior and the global economy as it decides how fast and how far to raise interest rates, Governor Philip Lowe said.

“Developments in each of these three areas will affect the pace at which inflation returns to target and whether the economy can remain on an even keel,” Lowe said in a speech Tuesday. “The board expects to increase interest rates further over the period ahead. We are not on a pre-set path though.”

The Reserve Bank is in the midst of its fastest tightening cycle in a generation, having increased the cash rate by 2.75 percentage points since May as it joins global counterparts in trying to get control of inflation. Yet it has also staked out a different stance to overseas peers by recently slowing the pace of hikes as it tries to deliver a soft landing for the economy.

Lowe reiterated the RBA is “resolute in its determination” to ensure the current period of soaring prices is only temporary and “will do what is necessary” to return inflation to its 2-3% target. The central bank’s benchmark rate currently stands at 2.85% — the highest level since April 2013.

In his speech, titled “Price Stability, the Supply Side and Prosperity,” the governor reiterated that the RBA is open to resuming half percentage-point increases if inflation fails to decelerate as forecast. At the same time, the board hasn’t ruled out leaving borrowing costs unchanged “for a time” as it monitors the impact of earlier hikes on households.

Responding to a question after his address, Lowe said he believes the RBA’s policy transmission mechanism that normally takes around 18 months to two years for maximum effect might be different this time around.

“It’s quite likely the lag is going to be a bit longer than it normally would be, and that complicates our task as well,” he said. The governor cited the large buildup in savings by Australians during the pandemic that is supporting consumption and the jump in people taking out fixed mortgages to lock in lower rates.

As a result, those on fixed rates haven’t been impacted by higher borrowing costs yet, but they will begin to pay them next year. In the meantime, that’s slowing the transmission of monetary policy, he said.

Supply-Side Inflation

Lowe also looked to the future of inflation in his speech, suggesting that consumer prices are more likely to be driven by supply-side factors than the demand drivers of the past due to:

• The “reversal of globalization:” international trade is no longer growing faster than the global economy while barriers to trade and investment are more likely to be increased than removed
• The global working-age population is declining and this trajectory is projected to intensify
• The frequency of extreme weather events has increased and is likely to continue, disrupting production and prices
• The energy transition in the global economy, with the investment response to recent higher commodity prices “negligible,” suggesting more supply constraints in future

Lowe described these developments as “first-order issues” that are likely to “affect the inflation dynamic here and elsewhere, leading to more variability in inflation from year to year.” He said if they do come to pass then there are several implications.

First, “it is increasingly problematic” to set a narrow range that inflation is always supposed to be within, the governor said, adding a “strong nominal anchor” will be more important than ever.

He highlighted that Australia’s inflation target with its focus on the “average over time” is appropriate, as is the flexibility provided by its medium-term target range.

A key implication of more variable inflation, he said, is that the monetary policy environment “is likely to be more challenging” for central banks.

“An adverse supply shock increases inflation and reduces output and employment,” he said. “Higher inflation calls for higher interest rates but lower output, and fewer jobs call for lower interest rates. It is likely that we will have to deal with this tension more frequently in the future.”

The remarks come amid an independent, government-mandated review of the RBA that is looking into everything from the board’s structure and governance to its mandate and objectives.

Lowe reiterated that the supply-side challenges don’t undermine the RBA’s ability to achieve its inflation target on average, though they are “likely to complicate the task.” That is one reason a strong underlying budget position is key, he said.

Resource: finance.yahoo.com