Transcript Panel Participation by Philip Lowe, Governor, at the UBS Panel discussion Central Banks and Inflation

Thank you very much for coming. And welcome also to those who are attending on the live stream on UBS live desk. Thank you very much for tuning in. We have a great line-up today here for you in Zurich. With the RBA Governor Philip Lowe, President of the St. Louis Fed Jim Bullert and ECB Vice-President Luis De Guindos. I’m not going to go through the CVs and highlight all the things they have done so far. Everybody here will know our panelists very well from the headlines, the interviews and the speeches. Though thank you very much for being here today. The way I thought we were going to do it today, is that I will go through maybe a couple of rounds of questions with the panelists with a few follow-ups and that usually takes quite a bit of the 90 minutes that we have. But then afterwards in the last part the audience will have the opportunity to ask questions and we will have microphones here. And just to say, this is a public event and there is media present as well.

It's a very exciting time, difficult time as well for us in markets, but certainly also for policy makers on the central banks. Let's go right away to Governor Lowe, and ask you in terms of the RBA, like many other central banks, you were surprised by the level of inflation that is now a reality in Australia. So one obvious question: what surprised you? Why do you think did the forecasters, not just at your institution but at others as well, get it so wrong?

Well, I was about to say it's great to be here, much better being here than on Zoom. It wasn't that long ago, back in 2021 even, that people thought that inflation around the world would be 2 or maybe 3 per cent by now. And there were many central banks, including my own, that thought that inflation would stay low and that we'd be keeping interest rates low perhaps until 2024. That was, up until late last year, that was a common view right around the world. A good question, so what changed? I think the first thing is that our economies have been remarkably resilient. The bounce back from COVID has been very strong, we see this in Australia with very strong demand. The vaccines have been effective, people got vaccinated and people are getting back to their normal lives, aren't they? Here in Zurich I've hardly seen anyone with a mask. The other thing that's helped the resilience, I think is that central banks and governments over-insured during the pandemic with their policy response. I know we did this, we had very strong focus on providing maximum insurance in case the worst happened. And the worst didn't happen. It was pretty bad but the worst didn't happen. So we over-insured and the health outcomes had been better than previously expected to be, so demand has bounced back very strongly in all our economies. So that's one thing.

Another thing that has led to higher inflation is the supply side problems persisted. Global supply chains are long and complex and it turns out if there is a problem anywhere in the chain then it reverberates right through the system and keeps putting prices up. We're still getting price pressures from supply chain disruptions.

And the third thing that changed, and this is something that no one could have predicted was, are the terrible events in Ukraine and the higher oil and food prices that are affecting us all. So you put together very strong demand on a post-pandemic rebound, over-insurance and the supply side problems and a war. It's not surprising that inflation is so high. The challenge we all are facing now is how to bring inflation back down as painlessly as we can.

[inaudible] markets and market pricing, there has been concerns starting to appear that we might go to recession. In Australia we have had a massive rally in 10-year bonds like 50 basis points in a week or a bit more. How concerned are you at this point that things could tip the other way?

At the moment, the Australian economy is remarkably resilient. We were the first advanced economy to get back to the previous level of output and employment. Our unemployment rate is at a 50-year low. You've got to go back to 1974 to have a lower unemployment rate in Australia. Labour force participation has skyrocketed. So the share of the population with a job in Australia is at a record high by a large margin. Our terms of trade are also at a historic high. Households have saved a huge amount over the past couple of years and the current saving out of income is still very high, much higher than it was before the pandemic. And the number of people who are falling behind on their mortgages, and businesses falling behind on their loan repayments, is very low.

So there's a huge amount of resilience in the Australian economy at the moment. I'm not expecting there to be a recession, but we're on a narrow path. Like other countries we have to raise interest rates and are facing uncertainties around how that's going to affect the economy and we've got the global uncertainties as well. So we feel like we're on a narrow path back to low inflation. I think we can navigate that path, but there are risks, and the risks come from both the global economy and the uncertainty around households and how they're going to respond to higher interest rates. The dynamic that is relevant on household balance sheets are housing prices are now falling. They're still up 25 per cent on where they were two years ago. So the news has a lot of focus on the fact that the house prices being down 1 or 2 per cent, but they're still up 25 per cent over the past two years. I presume housing prices are going to adjust further downwards, so that's another dynamic affecting household balance sheets. There is a path there to have inflation come down without the economy having too much pain, but it's a narrow path.

Just one more question, before going to our next panelist. In terms of China, we hear in Switzerland, we're obviously quite far away and our European investors are far away from Australia. And one thing that people often say is well we're treating the Australian Dollar as proxy to what's going on in China. What's your view currently in terms of the Chinese demand that you see for your exports? What's your, kind of, forecast there?

Our main export to China is iron ore, and the demand for iron ore is still pretty strong. Iron ore prices have come back down in the last few days but they're still, in a historical context strong, because the Chinese are still investing in infrastructure at a fairly fast rate. Not the rate they were investing before, but still a fairly fast rate. The two main issues we're watching in the Chinese economy at the moment. The first is their response to COVID. The fact that they're pursuing a near-zero COVID policy keeps leading to lockdowns in various cities, and that's causing further interruptions to the supply chain. So we're seeing the ripple effects of those interruptions throughout Asia. So that's one issue. And there is a lot of uncertainty. Very few countries have been able to achieve zero COVID cases, but China is seeking to do that and is prepared to pay in the short run an economic cost to do that. So that's one uncertainty. The other uncertainty is what's going on in the property market. For two or three years, they've been pursuing a program of de-leveraging. And we've seen failures in the property market in almost every other country where there is a wash-out in the property sector and de-leveraging comes with broader economic effects, and I think we're seeing some of those in China at the moment as well. On the other hand, there have been some efforts to stimulate, but they're not like in the financial crisis.

Governor Lowe, if I could go back to you and some Australian questions. You gave a TV interview last week, it's almost two weeks ago I guess now, which was initially interpreted as quite hawkish. It came on the back of a surprise 50 basis point hike, but then subsequently it seemed that you were taking the possibility of 75 basis points kind off the table. Just curious in terms of how do you calibrate like all the central banks … How do you calibrate what you're going to do? And I guess specifically, were you concerned that the market is then pricing in too aggressive a path and so you didn't want the kind of 75 basis point step priced in. Or how is this kind of interaction with the market for you?

I see it slightly differently. I don't see it as taking 75 basis points off the table, because it was never on the table. If you read the minutes from our previous meeting, we discussed 25 basis points or 50 [basis points]. And we decided on 50 [basis points] on the basis that we'd had a further upward revision to an already high inflation forecast and a recognition that interest rates at less than half a per cent that they were at the time. An interest rate of less than half a per cent wasn't appropriate for an economy with 5 per cent inflation and the lowest unemployment rate since 1974. So we decided that it was time to start moving up more quickly particularly given the inflation outlook. I don't want to forecast the next meeting but I suspect it'll be the same discussion again, 25 or 50 [basis points] again.

Just to draw your attention to two unique points about the Australian set up. The first is that the Reserve Bank board meets every single month, so most times there are only four weeks between our meetings. That's quite different to other arrangements where you might have eight meetings a year or some countries have even less. So we have a meeting every single month, which allows us to take more graduated steps at each of those meetings and to react to the data. So the frequency of our meetings is quite different than most other central banks. The other thing that's different, and this is a bad difference, is our CPI is only available quarterly. We do not – yes, you laugh as well … We've been working with the Bureau of Statistics to try and get a monthly CPI and maybe later this year they'll have an experimental series. But we only have one reading on inflation every three months. The next reading we will have for the August meeting – remember, we meet every month – so we'll have a meeting in July where we'll be discussing 25 or 50 [basis points] and again in August we'll have another read on inflation and we'll take stock at that point. So we're not really driven by the market expectations, we're driven by what we think is the right thing to do in the circumstances.

And so you … I mean in terms of ‘not driven by the market’, I mean how would you look at – and again this is a question that central banks watchers or investors debate all the time – how do you look at surprising markets? Is that a good thing, a bad thing? Would there be situations where you'd say, now we need to guide the market to price in a bit more or a bit less? Or you really don't care very much?

I don't think it's a good thing or a bad thing. It's just a thing. The markets will form their expectations and we'll take our decisions based on the information we have and what we think is the right monetary policy response for the country. Sometimes we're going to surprise markets, and that's neither a good or a bad thing. I hope that over time people understand our reaction function so that broadly they get the direction of movement right, even if they don't get the number of basis points right at each meeting. But we place a lot of weight on people understanding our reaction function rather than whether we're going to move by a specific amount at a specific meeting.

And then in terms of inflation, you have said that you expect inflation to go up to around 7 per cent by year-end and then start to ease off in Q1. And you sounded – you know – quite confident about that and I guess with base effects one can be quite confident, but still given kind of the repeated surprises that we have had and the consistently higher readings. Are you sometimes worried that this might actually not be true? How confident are you that the monetary policy that you currently have in place will bring down this inflation?

There are four things that underlie that assessment that inflation will come down. The first is that the year-end rate of inflation in the December quarter will be boosted by some government decisions. We've had a temporary relief from some taxes that goes away in the December quarter. So that's going to boost the year ended number. That won't be a factor next year, I don't expect. A second factor is that the problems in the global economy from COVID are gradually being resolved. We watch the price of computer chips very carefully, and while it's still very high, it is coming down. Auto production globally is starting to pick up and delivery times are improving. ….but not as bad as they have been before. We're seeing increasing evidence that the COVID related problems are being resolved and I think that will help. The third thing – and you mentioned this – is the base effects. In our own CPI the price of petrol is up 37 per cent over the past year. Is it going to be up another 37 per cent next year? Let's hope not. Even if petrol prices stay where they are now, the rate of increase in petrol prices in the CPI will go from 37 to 0 [per cent]. So that's added this year more than 1 percentage point to inflation, if things work out well that could turn into a negative. They're three important things. And the fourth one is that higher interest rates. Over time they will constrain spending in the interest-sensitive parts of the economy. So we've got four things together that give us reasonable confidence that inflation will start trending lower next year. That's not to say we might get hit by another shock.

But there are pretty powerful influences I just talked about. So we have a fair degree of confidence and the question we're now grappling with is how fast the decline in inflation will be. We've got a flexible medium term target of 2 to 3 per cent and we got to chart out a way back there. I think it will take us a couple of years. We don't feel the need to get that back there straight away, nor can we get back there straight away. We've intentionally had a flexible medium term inflation target which gives us time to get back to 2 to 3 per cent and as long as we can chart our way back there, we are comfortable with that. And I said before, it's a narrow path to get back there, but there is a credible path that we can get back there without economic activity suffering too much.

And I asked [inaudible] How are the risks that inflation is getting de-anchored in your view? And what do you look at it as a credibility of the RBA kind of thing? Or is it the function of timing, the longer you stay high in inflation? And how important are inflation expectations for you and they are obviously difficult to measure?

They are difficult to measure, but the measured we have are all still well anchored in the 2 to 3 per cent medium term target. So that's important. I generally think of this as a broader concept of the inflation psychology in the country. Most people in the community don't worry too much about whether inflation is 2.5 [per cent] or 3 [per cent] or whatever, but it's the inflation psychology that's important. For many years in Australia people didn't worry about inflation, it was not something you needed to think about. And businesses for many years said they really couldn't put up prices. No business person would stand in the public square and say they would put their prices up, because they would be hailed down. But now you can stand in the public square and say: I'm putting my prices up. I have to put them up, because of A B C and D. So the whole psychology about businesses putting prices up has shifted. And there has also been a shift in the psychology in the labour market. For the past decade, maybe two decades we haven't really had any indexation because people didn't worry too much about what the inflation rate in any particular year was, because they were confident that over time the inflation rate would be 2-point-something [per cent]. But now there's a very strong focus of … at least in parts of the labour market, of getting full compensation for the higher inflation. So it's not formal wage indexation, but it's indexation of a sort because you can understand that people faced with high inflation want compensation for it, especially with the unemployment rate as low as it is.

So there's a shift in the inflation psychology in the country. It's not really showing up in the survey-based measures of inflation expectations, but the willingness of firms to put up their prices has increased, and the willingness of labour to link wage increases to inflation has also increased. Given that shift in psychology, it's very important that we can chart a credible path back to 2 to 3 per cent inflation. If we can do that, then this shift in psychology won't persist. But if people start to worry that we can't chart that credible path back then I think the shift in psychology could be quite persistent and we know where that ends. It ends in persistent inflation and then you've got to have much higher interest rates and an economic downturn to get inflation back down. So as I said earlier on, I think there is a credible path we can get back and our communication and our interest rate decisions are meant to inforce that we are taking that path.

Chris Crowe, from Capula Investment Management. I was wondering in the interest of balance. If I could ask a short question to each member of the panel? Governor Lowe, you mentioned the sort of relentless rise in labour force participation in Australia, which is a really striking feature of the data, particularly in contrast with other countries. I was wondering how does that affect your policy decisions? Is it something you expect to continue? And if it stops, how will that affect your thinking? Thank you.

Thank you. Let me maybe go straight back to the panelists. Starting with you Governor Lowe.

You're right the increase in labour force participation is really one of the striking features of the Australian data. The strong demand for labour has been there and people have entered the labour force in a way that we didn't expect. Whether that's going to continue is hard to know. The other thing that's going to affect labour supply in Australia is the reopening of the borders. Before the pandemic, Australia was a very fast population growth country, with immigration adding more than 1 per cent a year to our population growth. Over the last little while, obviously there hasn't been any immigration, but as the borders have opened, people are starting to come to Australia again. So I think in the next period of time it's the increase in immigration which is going to be the first order effect on labour supply. So we're going to be watching that very carefully. On domestic participation it's just too hard to tell whether it's going to rise further because it's extraordinarily high now.

And maybe just to add on the second question in terms of the side effects, one could also put it in a way that you have a lot of things which were building during this long period of low inflation and QE. And now there is the question of unwind, right? So naturally one would expect things to become problematic here and there, because you're unwinding something that went on for a long time. So when you look as this unwind, be it QT or higher interest rates. What are the main risks? And would there be a point where you said: okay, now it's getting too dangerous and balance sheets have to stay much larger than they were before?

Can I get back to the question: Should there be more attention given to asset prices? In our case, we paid a lot of attention. But the more pressing issue was trends in borrowing. Asset prices move around, up and down, and interest rates are one factor, but there a lot of other factors as well. The increase in demand for floor space was an important factor driving housing prices up during the last few years. Our focus was very much on the trends in borrowing as we knew asset prices would go up and they would probably come down again and we wanted to make sure that borrowing was reasonably contained during the last view years. And so the central bank in Australia together with the prudential regulator, took various macroprudential steps to slow the growth, particularly in household borrowing.

But can I make a broader point about our mindset over past couple of years, was really an insurance mindset. And we were faced with a global pandemic with catastrophic effects for our society. In our case, people were predicting unemployment rates of 15 per cent. A generation of Australians, of global citizens having lost opportunity. We were told at the beginning that the vaccine would not be available for five years, if we were lucky, and then maybe it would be effective, maybe it wouldn't. So the situation we were all facing was really a catastrophe. And our central bank and the government wanted to take out maximum insurance against that catastrophe, and that's what we did. One of the side effects of that was higher asset prices, but the policy response did help avoid the catastrophe. And now that the economy has been more resilient than we expected, we have to raise interest rates and asset prices will come back a bit as a result of that. You could argue that we took out too much insurance and so we introduced volatility into asset prices. I can understand why people would make that argument. But the more pressing thing in the situation we faced was to provide the insurance for society and to make sure that while providing that insurance that people didn't borrow too much.

Jessica Fung from PALA Investments. I have a very different question to that one. Mine is related to sustainability. Obviously, we're in a business expansion cycle whether that's a continuation from pre-pandemic or coming out of a recovery, doesn't matter. But obviously, when we think about economic growth we want to do it globally, we want to do it more sustainably. And so the question I have for each of you is … Growing sustainably is going to cost society more, at least in a transition period, and maybe structurally over a period of time. So my question is, how much do you factor this into your targets, whether it's an inflation target or what you think is a neutral target? The fact that trying to be a little bit more sustainable in our economic growth is naturally going to result in higher prices across the board, possibly structurally. Just a question on how you factor this in and think about it?

I mean, in the short run I think there are some costs involved in the transition, some higher prices and we're even seeing that in Australia. Many other countries are seeing higher prices for energy as we make this transition. But I very much agree with Jim over the medium term there are huge advantages here. Australia is a country that historically has exported a lot of hydrocarbons. We're one of the world's biggest exporters of gas and have been one of the biggest exporters of coal. And we still generate a lot of our electricity through coal. But wind the clock forward a decade and that's going to change a lot. We've got a lot of land, we've got a lot of wind and we've got a lot of sun. So we are making a very fast transition towards a green economy. Green hydrogen has tremendous opportunities for us, particularly that we can produce green electricity cheaply because of all the land and sun we have. Over time, I think it is a huge opportunity for us. It means that we're going to have to invest a lot more in different forms of energy distribution and production. But in the longer term, this is not a cost, even though in the short term consumers do have to pay higher prices in some countries because in the interim the ability of the old system to meet that demand for electricity and power isn't there. So there are stress points, but over time it's going to be a huge advantage, including for Australia which has historically exported hydrocarbons.

Thank you very much. Unfortunately, we are out of time. Maybe I take one more question. In the middle. Hopefully, it's a good question. No pressure, but …

Thank you very much. My first questions is to Governor Lowe, so your assessment for the last meeting is that the current level of rates is very low given where inflation and unemployment is. And you mentioned that there's urgency to hike and adjust this rate. So I don't understand why you limit to 25 and 50 basis points increment steps. Why delay the adjustment?

Thank you. I guess we could talk quite a long time, particularly about the second question. But I ask you to give short answers please.

I'll be brief. I don't see it in terms of delaying. We meet every four weeks. So a 50 basis points increase in one meeting if we would follow-up with another 50 basis points in the next meeting that means in a short period of time, we would have a 100 basis points increase. So it's quite different to a central bank that meets once every eight weeks. The benefit of these frequent meetings is we get to take stock of the information at a very high frequency basis and are able to respond to the changing circumstances. So we meet often and I think that's important for people to remember.