Lowe warns about future hikes

  • By Zilla Efrat

Australians should be prepared for more interest rate rises, Reserve Bank of Australia governor Philip Lowe warned on Tuesday.

In a speech to American Chamber of Commerce in Australia (AMCHAM) in Sydney, he noted that interest rates were still very low for an economy with low unemployment and that was experiencing high inflation.

He said the RBA was expecting inflation to peak at around 7 per cent in the December quarter and to begin to decline by early next year.

“I want to emphasise though that we are not on a pre-set path,” said Lowe.

“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.”

Lowe said the RBA’s board was committed to doing what was necessary to ensure that inflation returned to the 2 to 3 per cent target range over time.

“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.”

But he added that the RBA did not need to, nor could it, 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,” he said.

“That path 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.”

Lowe said higher interest rates had a role to play here, by helping to ensure that spending grows broadly in line with the economy's capacity to produce goods and services. Higher interest rates could also directly affect expectations by demonstrating the commitment of the RBA to return inflation to target.

As it made that assessment each month, Lowe said the RBA board would pay close attention to developments in the global economy, the evolution of labour costs and how household spending was responding to higher interest rates.

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

“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, Lowe added that on the other side of the ledger, many households had not previously experienced a period of rising interest rates. Households were also experiencing a decline in real incomes because of the higher inflation and some of the large gains in housing prices over recent years were 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,” he said.