Transcript of Question & Answer Session Recent Economic Developments

Well, thanks Governor, for that address. I'm John Kehoe, the Economics Editor of The Australian Financial Review. Good to see you kept dry on the way here this morning, Phil. I wanted to start off by asking you about, for some time you've been talking about wanting to get inflation sustainably in the 2 to 3 per cent band, and that's why you're being patient waiting for wages to rise. But we're now likely to see, at least in headline terms, inflation get up to maybe 4 or 5 per cent in the next quarter or two because of the surging oil prices and pandemic supply chain crunch. So is there now potentially an asymmetric risk that, as Peter Costello said yesterday, it's very hard to see inflation going below that 2 to 3 per cent band. Alan Joyce was talking about putting airline price tickets up. But it's certainly quite foreseeable over the future to see it going quite a bit above that. And does that need to then change your calculus about when and how to raise interest rates?

Well, I think the risks on inflation have certainly moved to the upside, that's clear. And headline inflation is going to be higher. I think it'll have a number with a four in front sometime this year as the higher oil prices flow through. The issue we're grappling with is, is this a temporary increase in the level of prices, or is it a period of ongoing higher rate of increase in the rate at which prices are increasing? And the answer to that's still not known. I mean, it's quite possible that we have a period of high inflation as the higher commodity prices flow through, but to sustain that higher rate of inflation, we've got to have the commodity prices keep going up. Let's hope that doesn't happen.

To sustain the higher rates of inflation I think we've got to have wages growth above 3 per cent. Let's hope the country can deliver labour productivity growth of 1 per cent. And if it can, and wages are growing at 3, unit labour costs won't be growing at 2, and that's not going to sustain inflation at close to 2.5 per cent. So we're still paying a lot of attention to what's going on in the labour market. Sure, inflation's going to be higher for a while as these supply side problems wash through, but they may well wash through. And after they wash through, it's really going to be important what labour costs are doing.

At the moment, wages in aggregate are still growing with a 2 in front of them. That may change, and as I said in my prepared remarks, one of the things we're watching very carefully is how labour markets respond to high headline inflation. It's quite plausible, not just in Australia, but in other countries as well, that workers looking at high headline inflation rates and a tight labour market start wanting larger wage increases to compensate them for what is, in the United States and in the UK at the moment, a substantial reduction in real living standards in a tight labour market. So, we're watching that, from the risk to the upside.

Thanks for that. I do want to get to some audience questions in just a moment. I know Phil's keen to take some from the floor as well, so prepare what you might want to ask the RBA Governor. I'll throw in one more. You told parliament last month that ideally, you'd like to see a couple more quarterly inflation reports before considering raising interest rates. The second of those reports would be in late July, which I guess plausibly makes a potential August rate rise seem quite plausible. But what if you got a really strong inflation report for the March quarter and late April, which seems quite plausible. Could that change your calculus on interest rates? Could you do it without a second quarterly inflation report move?

We don't have a plan that's locked in. We're looking at every month, the data that's come in. And since that parliamentary appearance, Russia has invaded Ukraine and commodity prices right across the board have gone through the roof. So when we next meet, we'll have to put all that into the calculus and work out what the timing of the increase in interest rates will be. But we don't have a fixed rule we're using here; we're going to look at this complex world we live in and make a decision every month.

By and large though, it sounds like you're sticking to your guns on the wages, the labour costs. That's really going to be a key trigger point for the RBA.

It will. I think we can, given the history of low inflation in Australia, we can afford to look through a period of temporarily high inflation because of higher oil prices and commodity price shocks. If we think that they will eventually wash through the figures and then we'll be back looking at what the growth in unit labour costs is, and growth in unit labour costs are still pretty low. So that's still our main focus. Events can come along that shift the focus, but at the moment that remains the focus.

Well, let's turn to the floor. If you'd like to ask a question. Lady up the back. I think it's Lyn Cobley, if I can see her correctly.

Thanks for your speech, Phil. We're just interested, a lot of this conference pleasingly has been around climate change – quite topical with what's happening outside – and I wonder if you can just give us a snapshot as to the work the RBA has been doing in the last couple of years and certainly leading up to COP26 and beyond? I think the audience will be very interested to hear that. Thank you.

Well there are a couple of things I could pick up here, and Mark Carney talked about them. The first thing was we were very conscious last year of the views of international investors. Now every Zoom meeting I attend with international investors, people were asking about what Australia's climate change policy is? What are businesses doing? What are financial institutions doing? So, I've been very conscious of that and as a country, we need to have a credible story to tell and we do have a credible story now. I think we've got endless possibilities in this area as Mark was talking to, and it's up to business and government to seize that. So that's incredibly important.

Through the work that the Council of Financial Regulators are doing, there are two issues that I'm mainly focused on. The first is the importance of disclosure. Capital markets and financial markets can solve lots of problems, but they need information to allocate capital and Mark was kind of alluding to this. So Australian business and financial institutions, I think have to do a better job at disclosing their carbon reduction plans. And globally we need a template that people can use to have standardised information that people can trust, can read and understand. So that's something that through the Council of Financial Regulators we're working on, and I think it's incredibly important because capital markets can't do their jobs if they don't have the information.

The other element that we're working at the moment is the climate risk vulnerability assessments. We have been doing this with APRA, so that financial institutions understand the risk that they're running from a climate perspective. Mark spoke eloquently about that, how financial institutions need to understand those risks and they need to disclose them. So it's understanding and disclosure, they're the two key elements of it. In addition to just, as an institution, we understand how important it is that Australia remains an attractive place for international capital and we need to provide the disclosure that goes with that.

We are running tight on time, but I do want to make sure we get one more question from the floor. There's a gentleman up the front here. Just here. And if we've got time we'll …

Graham Cartwright. I wanted to just ask about the surge in revenue, obviously coming through from those increased commodity prices. And I guess using the language of yesterday, in the mid-2000s, just prior to the GFC, the RBA did put some nuts away on the basis that the mining resources boom was generating excess income and I think unemployment got to around about 4 per cent, so not far from where we are now. Does that sort of sway the risks that, you know, we're looking at a mini resources boom, and that's likely to lead to that inflation, which did come through in that 2006/7 period?

It's possible that happens but I think it's quite unlikely. Because for that to happen, resource companies would have to decide now to invest heavily on the back of higher prices, because that's what happened in the previous resources boom. China demanded a lot of steel. The price of iron ore and other commodities went up and Australian producers invested a huge amount. The economy was on the verge of overheating because of all the investment income. This situation is quite different. It's unlikely that resource companies are going to go out and invest a lot at the moment because of the higher commodity prices. Hopefully they'll invest a bit more, but not expecting a boom. And as I said in my prepared remarks, we're expecting a lot of this extra national income to be saved this time because resource companies aren't likely to invest a lot.

I suspect, I don't know this, but I suspect the governments aren't going to spend a lot of this extra revenue. They'll take it through to the bottom line after having borrowed a lot in the last couple of years. And households aren't going to feel the benefits of the national income. What they're going to feel is higher petrol prices. So they're not likely to increase spending. Investment's not likely to be higher, government's not likely to spend more and households aren't going to spend more. So I think most of this extra national income will flow through to the bottom line in terms of national saving. But I could be wrong. If the resource companies decide, ‘God, this is a fantastic opportunity to once again expand the capital base’, that could be different. But I don't see that at the moment.

Well let's do one final quick question up the front here.

Yeah, thanks very much, David Rowe from Stockland. Phil, probably early days, but how's the Bank thinking about the floods and the impact to the economy, and then subsequently inflation as well?

Well, the impact is obviously catastrophic for the communities and we're seeing production, obviously in those communities suffer. And even here in Sydney, there's a lot of dislocation, so that affects the way that many businesses operate as well. So there will be an economic cost to that. We will see higher prices for many fruit and vegetables. The supply chains have been interrupted again, and some of the growing areas have been very adversely affected. So we'll see higher prices for those, which again, I think will be evident for a while, but again, they should pass through the calculations over time. So I don't see that as a source of ongoing inflation, but it will be noticeable.

And in time there'll be a rebuilding effort. There's already a large pipeline of construction activity take place in the country. This will add to that pipeline, because they'll have to be rebuilding and hopefully there'll be efforts at more flood mitigation over time. So this will provide a medium-term boost to offset what is obviously a very difficult period right now.