Transcript of Question & Answer Session Today's Monetary Policy Decision

Thank you. The first question is from Tapas Strickland from NAB. Please go ahead.

Good afternoon, Governor Lowe. I just wanted to get some clarification on what exactly inflation being sustainably at target is, if it's not necessarily linked towards wages growth at a specific rate. Are you able to elaborate on how long inflation needs to be within the 2 to 3 per cent band to be considered to be sustainably at target? Thank you.

Thank you. We don't have a specific rule here, but let me explain our general thinking. It's not going to be enough for inflation just to trip across 2 per cent and be 2.1 per cent for a quarter. We'll want to see inflation above 2 per cent for a number of quarters, and we'll want to be confident that we'll stay within the 2 to 3 per cent range.

In terms of seeking that confidence, we'll be looking very much at growth in wages. As I said, for inflation to be sustainably within 2 to 3 per cent, wage growth will have to be sustainably above 3. So first of all, we've got to get there. We've got to get above 2 per cent and sustain that for a while. And then when looking forward, we've got to be confident that it's going to stay there, and I think wages growth will be key to that.

So we don't have a rule, but that's the general approach we'll be taking. First, get there, and then be confident we're going to stay there, and in seeking that confidence, we'll be looking very much at wages growth.

Thank you. The next question is from Ross Greenwood from Sky News. Please go ahead.

Governor Lowe, 2 related questions. The first is in regards to your view of what is full employment now. Does that, in your mind, have a 4 in front of it or 3 in front of it? And the second one is in regards to wages inflation. How much of your assumption is based on the timing of the reopening of international borders?

In terms of full employment, I wish I knew the answer to that question. I suspect what we've got to do is keep the unemployment rate in the low 4s for a period of time. One reason I'm uncertain is we haven't been in that territory very much in the last 40 or 50 years. We were at 4% unemployment for a brief period during the resources boom, but it was only for a brief period, and then you've got to go back more than 4 decades. So we don't have very much historical experience to draw on. The evidence that we do have, though, suggests that we have to have an unemployment rate below 5, and I think probably close to 4 per cent. Time will tell, though. I hope we can do better than that, but we don't have very much historical experience to draw on.

You asked about whether the forecasts are conditional on opening of the borders. In the short term, the closure of the borders is having a significant effect on the economy. It's obviously affecting people's lives and it's affecting business decisions and it's affecting the labour market.

We're working under the assumption that sometime over the next year, the borders will be gradually opened, particularly for workers who have skills that are in short supply. If in 18 months or 2 years we're still in the situation that we're currently in with the borders closed, I think the inflation and wage dynamics will be quite different. But I think it's a plausible central case that over the next year, we see a gradual opening of the borders, particularly for workers who have skills in short supply. Time will tell, though.

Thank you. The next question is from Phil O'Donaghoe from Deutsche Bank. Please go ahead.

Governor Lowe, today you've indicated that you do not expect conditions for a higher cash rate to be in place before 2024. I was wondering, though, if you could walk us through what will happen to the yield target if rate hike conditions emerge more quickly than you expect? So for example, if you ultimately see a hike in 2023, will you simply raise the overall '24 yield target as well, or does it make more sense in that scenario to simply abandon the target altogether?

We're talking hypotheticals here, aren't we? But in principle, the cash rate target and the 3 – I shouldn't call it the 3-year yield target anymore – the yield target go together. So we think about those as a package. As I said in my opening remarks, we still are of the view that it's unlikely that the cash rate will be increased before 2024, and perhaps let me run through that logic again.

For inflation to be sustainably within the 2 to 3 per cent range, I think we're going to have wage growth above 3, as I said. The last time wage growth was above 3 per cent in Australia was a decade ago. Over a decade, it went from above 3 down to 1½. I don't think it's particularly likely that it shoots back up to above 3 per cent over the next 18 months. Wage increases will get a bit larger, but aggregate wage growth I think is likely to be below 3 per cent for the next couple of years. And until wage growth is above 3 per cent, I have trouble with the notion that inflation could be sustainably in the 2 to 3 per cent.

So if you think we're going to raise interest rates in 2023, you've got to have a much more positive forecast of wages growth than we currently have, which would require the dynamics in the labour market to be very different to those that have been at work over the past decade. Those dynamics have been pretty powerful. There's been a big increase in labour supply. I spoke last week about the mindset of businesses, about their perceptions that they have difficulty raising prices, and therefore they want to keep control of their costs. So all those dynamics would have to change fundamentally to get wages growth up above 3 per cent in the next 18 months and therefore inflation higher than it currently is.

So that's the logic for thinking that inflation is not going to rise sustainably to be in the 2 to 3 per cent range until '24, and therefore interest rates.

Thank you.

Thank you. The next question is from Shane Wright from The Age. Please go ahead.

G'day, Governor. I just want to follow up on the question that Ross asked. What do you believe or what do you think the impact of the reopening of the international borders means to the jobs market and to wages growth? Is that part of your central scenario that that is a downward pressure on wages growth and on jobs growth?

Well, the opening of the borders will be good news for the economy, won't it? So it'll be good news at kind of the individual level. People will be able to go and catch up with family and friends and travel internationally again. But it's also important for businesses. We hear reports from businesses we talk to that one of the reasons they're not investing at the moment is they can't get the skilled workers from overseas to put in place new capital equipment or test it out. So it's affecting business investment at the moment. So it will be good news for the economy when the borders open.

At the moment, as I said before, the closure of the borders is affecting the market for some skills, some type of work, some type of labour, and it is putting upward pressure on the wages for those people. If and when we open the border, I think some of that pressure will come out of the system. But until that's the case, I think we're going to see these pockets of pressure remain, and it's going to be there until the borders open.

So one possibility here is that the borders stay closed for an extended period, wage growth lifts and we re-establish norms of 3 per cent for wages growth rather than the current norm of 2per cent. And then the borders is open, allowing businesses to expand and invest again. So it's a first-order issue, both in terms of constraining businesses' investment and output decisions and in affecting the labour market.

Thank you. The next question is from Stephen Halmarick from Commonwealth Bank. Please go ahead.

Thank you. Thank you, Governor, for the opportunity. I'm just thinking about the quantitative easing program. What type of conditions would have to be met for you to consider a further tapering of that QE program come November? And I guess the related question, which relates to Phil's question, what type of conditions would you need to see to bring forward that cash rate guidance of 2024?

Well, on the cash rate guidance, for that to fundamentally shift from '24 to '23, we would need to see strong, unequivocal evidence that the pick-up in the economy is translating into wages growth and inflation more quickly than we had expected.

As I talked about a few minutes ago, there are these really fundamental and structural factors that have kept wages growth low for a decade. So we'd need to be convinced that those factors have gone away and been replaced by a new set of factors. It doesn't seem particularly likely. We can't rule it out completely, but it doesn't seem particularly likely.

In terms of the bond purchases, again, we will first want to see clear evidence that the stronger economy is leading to a pick-up in inflation pressures, and to date we haven't seen that. The economy's surprised massively on the upside, but the wage and inflation outcomes have been pretty much in line with our expectations.

So we have not yet seen evidence that the stronger economy is translating into stronger prices and wage pressures. That reflects some of the structural factors that I was just talking about. Those factors will gradually wane over time, but before we scale back bond purchases further, we'd want to see further evidence or some evidence that the stronger real economy is translating into a strong nominal economy. We're waiting for the evidence here. We hope and expect that this will happen, but it's a slow and drawn-out process.

Thank you. The next question comes from Michael Janda from ABC. Please go ahead.

Philip Lowe, thank you for the opportunity. The Reserve Bank of New Zealand, the Fed and the Canadian central bank have all been hinting at rate rises in 2023 or even potentially as early as next year. First of all, what effect does that have on your outlook and thinking around rates, if any? And secondly, Australia is supposed to have had one of the best economic recoveries through the COVID pandemic. If those central banks are talking about rates rising potentially as soon as next year, how come we're still looking at 2024?

We're certainly not hinting at rate increases in 2023. If other central banks increase rates in '23, the main transmission mechanism of those increases to us is through the exchange rate. You would expect their exchange rates to go up a little bit and the Australian dollar to depreciate against the currencies where the central banks are increasing rates. So that's one transmission mechanism. It's not particularly powerful, but it is one.

The more fundamental question is why are other central banks even hinting at interest rate increases in 2023 and we're not? And the answer to that is, first of all, that the inflation outcomes in Australia are further away from the target. In Canada, the underlying inflation rate is quite close to the Bank of Canada's target.

Here in Australia, we've been below the target for too many years, and the prospect of reaching the target in the short term is not particularly high. It's partly linked to the issue of wages, that I talked about. Wage growth in Australia had slowed by more than it had in most other countries, even before the pandemic, and we had a particularly large response in wages during the pandemic as well. So wage growth had fallen by more, and has stepped down again during the pandemic.

So even though the real economy in Australia has been much better than in almost any other western country, the outcomes for inflation and wages have not been better. And we're further away from where we should be on both those key variables, which the central bank is responsible for. So we want to do what we can to get those nominal variables, that is, wage growth and inflation, back to target. I think it's really important we do that, because sometimes people say, Well, why do you want to get inflation back to 2 to 3 per cent? And the main reason that we want to get it back is if we can get inflation back to 2 to 3 per cent, then over time interest rates can normalise and be higher, and that gives us the capability to lower interest rates in the next downturn.

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We're very focused at the moment on the current downturn, rightly, but we know in the future, there'll be further downturns in the economy, and we want to have a monetary policy tool to respond to those downturns. So it's important for macroeconomic management that over time, interest rates can normalise, and interest rates can only normalise if we can get the nominal part of the economy growing around the target.

We want to make sure that happens, and we'll keep the monetary stimulus going until it does. And because the inflation and wage outcomes have been lower in Australia than other places, we're going to keep the stimulus going probably longer than the other countries.

Thank you. The next question is from Tapas Strickland from NAB. Please go ahead.

Thank you, Governor Lowe. I just wanted to elaborate on some of your comments in the post board statement on house prices and the strength in the housing market, and you noticed that there has been an increased borrowing by investors. Are there any indicators that we should look at that would concern you that would prompt the RBA and APRA to tighten up macroprudential tools? Thank you.

Thank you. I don't want to highlight any particular indicators, but perhaps I can highlight further the issues we're focusing on. We had an extensive discussion of this at the most recent Council of Financial Regulators meeting. We're looking very closely at the banks' lending standards. If we saw a deterioration in those lending standards, then both APRA and the Reserve Bank would be looking for actions, as we did a number of years ago. At the moment, I don't see any evidence that there's been a deterioration in lending standards, but we're watching that carefully. So that's one issue.

The second issue is the sustainability of trends in household credit. Credit growth has picked up. It's running at 6 or 7 per cent and it's going to pick up further. What neither APRA or the Reserve Bank want to see is credit growing too quickly relative to people's incomes. We've in Australia got quite high levels of household debt already. In my view, it's not in the country's long-term interest to have debt increasing at a much, much higher rate than people's income. So if we saw a large and sustained gap in household credit growth relative to income growth, then we would be looking at various policy responses to deal with that. So it's really about the sustainability of the trends in household debt relative to household income.

At the moment, we haven't got a problem here. Household debt growth, it's higher than income but not massively higher. But if we got to a situation where household debt was growing much, much quicker than income and that looked like it was going to be sustained, you could expect us to be exploring options a bit more aggressively than we are now.

The type of things we've been considering, there are 3. Looking at the interest serviceability buffer, the buffer that banks have to add onto the interest rate they charge you when they're making the loan. I notice that in Canada, they've increased that buffer recently. We're also working through the merits of portfolio loan-to-value restrictions and portfolio debt-to-income restrictions. So they're the things that we're working through. I don't see a need to move on any of those areas at the moment. Ultimately, it's a matter for APRA, but we're watching very carefully the trends in household debt.

Thank you. The next question is from Peter Ryan from ABC. Please go ahead.

Yes, good afternoon, Governor Lowe. Thanks for the opportunity this afternoon. I just wanted to get your views on the current situation with vaccines. There's a lot of, I guess, confusion or frustration about the delays. Are you concerned that delays or the sluggish rollout in the vaccines is becoming a big complication in the economic recovery?

Well, I think the sooner we can all get vaccinated and open up, the better the economic recovery is going to be. That's stating the obvious. So I understand people's frustration. The closure of the borders and the slow rollout of the vaccine is affecting people at a very personal level. It's also affecting businesses, I talked about before. But I do think we also need to remember that we will get through this and we need to be patient. In the foreseeable future, let's say by the end of the year, within 6 months, most of us will be vaccinated. Our lives will start to return to normal. We'll be able to travel again and enjoy one another's company, and businesses will be able to do the things they need to do to employ people and invest.

We all want that to happen today, and it's understandable we want that to happen today. I think we've got to be patient and within 6 months' time, I think most of us will have at least had one shot of the vaccine, and life will start returning to normal. That will happen more quickly the more of us get vaccinated. So it's not at the moment a concern for the medium-term outlook for the economy, as we're working under the premise that by the end of this year, the vast bulk of people who wanted the first shot of the vaccine will be able to have it. I think we'll start to see things return to normal then. But we need to be patient and not forget that within not too far in the future, most of us will be vaccinated. We want it to happen earlier, don't we? But it will happen within 6 months.

Thank you. The next question comes from Prashant Newnaha from TD Securities.com. Please go ahead.

Good afternoon, Governor Lowe. At the moment, the Board feels fairly comfortable with the economy bouncing back after restrictions are eased. I just wanted to get an idea on how the Board sees upside risks versus its central forecasts, given the current lockdown. And does the Board have a view on where they think the peak in the cash rate is in this cycle?

We have not discussed the peak in the cash rate. It's at the floor, and we're not looking forward to the peak and it coming down again. So I can't answer that, I'm sorry. And the first part of the question was?

It was just in regards to how comfortable does the Board feel with regards to the upside risks versus their central forecasts? Are you having a few doubts on your central forecast as you see the risks on the upside, despite the current lockdown?

Well, the economy's clearly been stronger than we'd expected, so I think in the next forecast round, we will see further upward revisions to the forecasts. Just to kind of wind the clock back to February. In February, we thought the unemployment rate today would be 6½ per cent. It's 5.1. And we didn't think we'd be getting back to 5 per cent unemployment until mid 2023. So we've done a lot better than expected, certainly since February, and even since May, the data have come in better than expected. So I could imagine that when we go through the forecasting process over the next month or so, there'll be further upward revisions to our forecasts. What we haven't seen is the same upside surprises on wages and inflation, so this is really what we're looking for.

You asked about upside risks. There's a potential upside risk to wages from the closure of the borders. As I said in answer to a previous question, if the borders remain closed for a very extended period of time, I think we'll see more and more of these pressures in the labour market that we're currently seeing, and it's conceivable that could change the dynamics in the labour market. Some people might think that's positive, but it comes at the cost of businesses not being able to get the people they need to do the investment and expansion.

So there is an upside risk on inflation and wages from the closure of the borders. We're paying close attention to that. I expect, though, that over the next 6 months to a year, the borders will gradually open, particularly for people who have skills in short supply. If that doesn't happen, we'll see more of these hotspots in the labour market.