Transcript of Question & Answer Session Channels of Transmission

Thank you, Chris. I’ll start with a few questions and then I’ll open the floor to questions, first from our guests and then from the media. So, Chris, with lags in transmission still being felt in the economy, does that mean no more rate hikes and that we’re at the peak now?

The interest rate question: it’s a good question. I’m going to step back for a minute and describe what I think are broadly three parts to the phase we’re in of raising rates. The first part was a quick – a very quick – and strong recovery in demand following the pandemic. That was accompanied by some pretty severe supply shocks, so that led to very high inflation – demand well in excess of supply. So that was a story of taking away the very stimulatory monetary policy settings and raising rates pretty quickly. That’s the first part. The second part then followed when we were trying to get rates – a little bit more slowly – but still trying to get rates into restrictive territory. In my speech, I tried to convey the fact that I think we’re there. We know demand growth is slowing, inflation is falling, labour market conditions are easing. Lags in policy, as you’ve said, mean there are still some further effects. And now I think it’s possible, having done that, to be in this third phase, if you like, where we have an opportunity to see how the economy and how the data is evolving. The Board’s going to be very much focused on those things I mentioned: global developments, trends in household spending, what’s happening in the labour market and, ultimately, the outlook; in other words, the forecast for inflation and economic activity. And, as I said, they’ve noted, after the most recent meeting, some further rate rise might be needed. I think it’s important to recognise because high inflation is such a problem for all Australians, it’s important to try and get inflation back into the target in a reasonable timeframe. But we’ve made quite a bit also of the fact that the Board is mindful of trying to retain as much of the employment growth as possible because that’s really critical for Australian welfare as well.

So another way in which economists have pointed out that you can still tighten monetary conditions is if you do active quantitative tightening. There was widespread expectation that it would be discussed in the October meeting, but we didn’t see that in the statement. Do you have any update for us?

Well, some update but not much. We don’t have any current plans to sell bonds to pursue what’s called ‘active QT’. At the moment, it’s a passive QT strategy. So we’ve had about $26 billion worth of the bonds we’ve bought mature to date – there’s quite a bit more still to come – and we said, back in May, that we’d review that approach from time to time. A couple of the things that we’re going to be thinking about is, if we were to pursue a policy of selling bonds, we’d want to do that in a way that wasn’t disruptive to the markets and wouldn’t disrupt the AOFM’s issuance activity, so that’s the first thing. But the Board’s also conscious of the fact that a large portfolio of shares still on the balance sheet implies interest rate risk that they need to think carefully about. So those are a couple of the considerations. It’s not about financial conditions though, I think, particularly because, as I said, the long end of the curve is less relevant for Australia. But we have an instrument – it’s called the ‘cash rate’ – when you’re off the effective lower bound … you can move that around, as you need to, to tighten financial conditions. The other thing and why maybe October was on people’s minds was the roll­-off of the Term Funding Facility. So a big chunk of that, I think it’s about $80 billion, was due at the end of September; so that got paid back, so that’s great. That went pretty smoothly. We didn’t know that going into it. We didn’t have massive concerns, but you wanted to watch that carefully; that went pretty smoothly. There were some effects. You could see it in various markets. Banks went out and issued a lot of bonds, but they were able to do that pretty successfully. For a time, they were issuing a lot of bank bill swaps over that period, and that pushed those rates higher for a time; they’ve come back. So all pretty smoothly. But there’s another really large chunk coming June of next year – by the end of June – another $108 billion. So nothing yet but when the Board feels the need to tell you that we’ve had another look at it, reviewed the case –

So was it discussed in October, or was it not?

You’ll have to wait for the minutes. I can’t reveal what was discussed.

Fair enough. A global question: we’ve seen a big increase in US Treasury yields over the past month and, in recent days, several Fed speakers have come out and said that it is tightening monetary conditions for them and doing the work for the Fed. We have seen yields go up in Australia as well. What are the implications here, and do you feel that is doing the job for Australia – for the RBA as well?

It’s obviously quite a focus for markets and central banks at the moment what’s happening in those important markets. There are two parts probably to my answer. I think the first thing is: it’s worth thinking about what’s causing those yields to go higher. There are a number of factors. I don’t think it’s a sign of problems in the US Treasury market in terms of the way it functions. I think there are other things though: a broad rise in uncertainty about the economy, about inflation. Some of that is geopolitical most recently but, broadly, supply shocks: what’s the path of inflation, how persistent is it going to be, what’s the trajectory for growth over the longer term? There’s considerable uncertainty about that. In the US particularly, there’s been a big rise in issuance as well, at the same time as the Feds letting their portfolio of bonds roll off that they bought through QE. So that’s having an effect. I think, in Australia, some of those factors are at play but particularly not on debt, deficits and issuance. We’re in a fortunate circumstance where we’re running fiscal surpluses at the moment. The other part of my answer is the long end of the yield curve, as I’ve already suggested, matters a lot less in Australia. It’s not unimportant, but it just matters a lot less. Most of the funding here is at the very short end of the curve. So those sorts of moves have a lot less of an implication for us than they might in the US.

I really, really loved that speech, Dr Kent. I’m just wondering: I remember a few summits ago, I think there was analysis on the relative impact of the total transmission mechanism on activity and inflation in Australia compared to our peers, such as the US, Canada and the UK. I’m just wondering if that analysis still holds and whether you’ve re-evaluated that analysis, in light of the research that you would have undertaken for today’s speech.

If I’m remembering correctly, I think the broad thrust of what we were trying to convey was, even if the cash flow channel, which is what I was talking about today, is so obvious and quite strong in Australia and happens with some immediacy, if you look back over past cycles of interest rates going up and down, you don’t see a lot of variation in the magnitude of those. If our policy was so much more effective over all of those channels and we were being hit by the same sorts of shocks, we wouldn’t necessarily have to do as much. But we do, and that tells you the cash flow channel is important here; others net less important than in other economies. I don’t think that sort of broad assessment has fundamentally changed, but I’d also caution not trying to pin these things down too tightly; because any time you run these models, if someone comes up with a point estimate, they’re missing the point. They should be telling us how much uncertainty around these things there is. So, more or less, similar sorts of effects, with slightly different timing and different channels, which was the point of my presentation today. Thanks.

Thanks very much for your speech, Dr Kent. Early on in this cycle, an argument from the RBA and the market was that wage setting mechanisms in Australia were different to overseas, which was the reason why we didn’t have to go as early or as fast, in terms of hiking rates. It now appears that may be somewhat changing, with the last couple of months of EBA data coming in, with agreement setting at over four per cent, and obviously we had a very large award wage rise this year and last. Obviously, some of the other private sector measures have been coming off a bit. But how are you thinking about wages and, potentially, the risk that, when you combine them with very weak or zero productivity growth, that creates upside risks for the inflation outlook, even if some of the other factors are starting to fade as supply chains normalise?

My response would be that you’re right: there are pockets of stronger wage growth, particularly of late, that are obvious and quite prominent. But when you step back and you take a broader look at the whole market, some of those things are applying to small segments of various parts of the market. The broad picture, I think, is one where we’ve had a higher nominal wage growth than in the past, of late, but it doesn’t seem to be pushing higher. That’s also the message we’re getting through liaison. So it doesn’t mean you’re not going to be able to find examples where that does seem to be the case, but the broad aggregates at the moment are saying that’s not happening. But as we’ve pointed out before, that’s fine; the current nominal wage growth doesn’t put at risk achieving the inflation target, so long as we can get a turnaround in productivity. So our forecasts are still predicated on a pick-up in productivity, which has been weak and even declining on some measures. I think there are reasonable prospects for that to happen, but that’s just another thing the Board’s going to be looking at closely. The challenge, of course, is pinning that down in real time. The estimates come late; they’re highly variable. A good way to think about what matters is, ultimately, what matters for inflation. So looking at inflation gives you a lot of timely information on all sorts of cost pressures, not just wages.

Thanks, Chris. You mentioned several transmission channels. Just for one of them, credit channel, I’m just wondering: what’s your observation and take for the recent development of private credit business and its impact on this, and especially its impact on the monetary policy?

I’m sorry; I didn’t quite catch what – the impact of which?

Yes, so private credit, because banks – obviously, they are, I mean, not lending as much as before, but many companies are lending directly to individuals, high-net-worth individuals and businesses, and I’m just wondering what’s your observation and your take on this and, of course, its impact on monetary policies. Thank you.

So, if I understand that question correctly, it’s about new forms of credit and finance that are not necessarily traditional channels through the banks. The biggest non-bank source of credit is often through non-bank financial institutions that raise a lot of funds by securitisation, so they bundle loans together. I know that’s not necessarily what you’re talking about, but they’re kind of the next biggest in town. They generally, compared to during the pandemic, have had a higher cost of funding through that source – coming off a bit more recently, but a higher cost than the banks. So their funding costs have been going up more than banks and so their extension of credit has been a bit less. But even that source – and I know you’re talking about something different again – that source only accounts for about four or five per cent of total credit. So the big story is still what’s happening on the banking side of things. And, when you look at credit, whether it’s to businesses or households, it’s come off. Households sitting around a four per cent annualised rate and doesn’t look like it will push higher; business credit has come right down as well. That’s not just the credit channel, but that’s the sort of thing you’d expect from the credit channel. So I think that’s monetary policy having an effect, even if there might be some other marginal sources which are growing.

Thank you for the speech, Dr Kent. Could you describe a little bit about the modelling on, say, the asset channel effect of higher interest rates, given that house prices haven’t declined perhaps as you might have expected and they’re picking up again with higher population growth. What is that, I guess, factor in your estimation where interest rates are going to go? Could we expect rising house prices to shift the odds for, say, another interest rate rise? How much more, if you like, would house prices have to move before your modelling changes?

I noted in my speech you’d normally expect house prices to have come off, and that’s what they did through last year, if the biggest effect operating on them is just interest rates. But there are these other factors. It’s hard to deny that a rise in house prices is stronger wealth than otherwise. I think the thing that makes me a bit cautious about saying, ‘That’s going to be problematic and drive consumption,’ is there are so many other features weighing on consumption at the moment. And, quite often, it’s hard to really identify this wealth channel accurately and consistently over time because things are always a bit different. And the thing that’s a bit different this time, from previous increases in house prices, is interest rates are rising, the credit channel is still at play. Turnover is still fairly low, it hasn’t really shot up, and that’s consistent with the point I was making about: if you were a borrower going out, compared to before when we raised the cash rate, the banks, which are the largest source of credit, will give you 30 per cent less, on average, than in the past. So it’s hard to see, in that environment, it being a major concern, but it’s still something we’d be watching at throwing into the mix and influencing the outlook for activity and inflation.

Good afternoon. Thanks for your talk, Chris. The market has seen the Reserve Bank being on hold for the past four months and is wondering if this is the peak or maybe the Reserve Bank will go further. The expectation is that the Q3 CPI – I think it’s late October – is something that could make or break a hike in November. You’ve said that the outlook for inflation is the single most important thing for the outlook for policy. Is the CPI going to be enough to shift the Bank given the weak household sector, given the weak China and the weak Europe? Might the CPI be important enough to make or break? Is it a little surprise you need on the upside or a big surprise, to get the Bank moving again? Thank you.

Well, you’ve asked all the good questions the Board need to be asking themselves come November. The CPI is important; it’s the thing we’re targeting. As I suggested earlier, it gives you quite a lot of information on a timely basis compared to things like unit labour costs, which come with a lag, measured not particularly well – it’s not the fault of the ABS; it’s just the nature of the beast – and subject to lots of revision. So it’s absolutely an important thing to be looking at. But it’s not the only thing we’re going to be looking at. We have to put that together with the pictures of what’s happening in the labour market and, as you’ve suggested, what’s happening to the household sector. Housing spending is such a large part of total spending in the economy, and that seems particularly weak at the moment. The labour market, thankfully, is easing, and a lot of that is vacancies coming off. So I don’t like to suggest there’s just one thing and there’s one threshold and it’s a done deal. It’s much more putting the whole picture together and we’ll look at all of our forecasts. But that’s an important variable. And that’s why, I think, if you ask market economists, which we do and others do … they’re focused on November, partly for that reason, as an important meeting, the OIS curve is giving some probability to that but not much and it’s pricing a bit further out.

Thank you, Chris. I wanted to ask about the interaction of monetary and fiscal policy. Of course, last year, the federal government ran a big surplus, the first in 15 years, but going back to deficit this year; Queensland is doing the same thing. If I look at the fiscal stance of federal and state together and the change from last year to this year, at least on my estimate, it’s about two per cent of GDP in stimulus, the biggest increase in fiscal stimulus outside of the GFC and COVID in 20 years. You note in your chart also that dwelling investment is very weak. The government’s got a target of 1.2 million houses in the next five years; that’s going to require the level of dwelling completions to increase by 25 per cent from current levels and stay there for 20 quarters. Is fiscal policy at odds with monetary policy, and is that putting more work on the RBA?

Our forecasts already try and embed as much of that as we can, both the federal and the state. I think it’s great that you’ve mentioned the state governments matter as well. And the states are also thinking about their investment programs and the fact that they’re costing quite a bit – that’s an environment of high inflation – and what they might do to slow some of these. So you’ll always be thinking actively about monetary policy and fiscal policy, but we try and take that stance as given. And I think it’s important to recognise as well, at least at a federal level, things like the automatic stabilisers are at play here, and you could see that in my graph of household disposable income. The tax take is something weighing on household disposable income. I think that’s an appropriate sort of approach. That’s part of the reason why in a strong environment of inflation but also employment growth, very strong employment growth, that’s a natural and appropriate thing to happen. So, we try and take all of those things into account as best we can, and we keep an eye on changes there. I think that’s already in our outlook: for inflation to come back gradually. But things are heading in the right sort of direction. The labour market is easing and consumption growth is pretty weak.

I just want to ask about the target to bring inflation back into the desired band by late-2025. In the speech, you seemed to indicate that, there could be other issues of urgency which could even change that glide path, in terms of trying to maintain as full employment as you possibly can. Can you just explain what things could knock you off that glide path, in terms of trying to maintain the jobs while bringing down inflation to that target band by the end of 2025?

I would step back from it all and say we often talk about our central forecasts. I like to think in a world where it’s very hard to forecast; it’s even hard to know where you’re currently at right now. I think we’ve got a reasonable handle on where we are right now but then, by the time you go out that far, there’s a lot of uncertainty. So it’s really a matter of just keeping an eye on things as we go. I think, in the past, we’ve made it pretty clear we would be not wanting to see inflation take much longer. But you’d have to add up a lot of different factors that would all move in one direction, it’s possible that that was to happen, for the Board to want to react. They’ve said they may need to raise interest rates in the future to bring inflation down. I think that’s a reflection of the fact that we wouldn’t want it to be much slower. You can tell all sorts of stories as to why that would not be the case. One concern would just be inflation expectations resetting if there were some further significant upward shocks. You can tell whatever stories you like about what might cause those. But at the same time, household demand, as it was suggested, is pretty weak, and that could be the sort of thing, that weakness, that turns the labour market a bit faster; that eases conditions there and brings inflation down faster. So there are lots of possibilities, but I think I would be the first, and that’s what I used to do when I was (the Bank’s) chief economist, to emphasise just how wide those bands of uncertainty are, and it means it’s a constant job of just looking, monitoring, trying to absorb things. But it’s not one thing that will do it; it’s a mix of things that would set you off on one course either way.

Thank you so much for your presentation. We’ve seen oil rises spiking again and geopolitical risks arising. How concerned are you that we’re going to see inflation spike upwards again at the same point as we’re seeing weakening demand in consumption?

Well, those are kind of alluding to some of the things that I think Ross was hinting at. But if you put those two together, the effect – it could be offsetting. Higher oil price is an important element but not the only element that goes into input costs and inflation, but weaker demand kind of works the other way. So I think it would be depending on the balance of those sorts of things. Remember, commodity prices generally: if they’re high, including oil prices and gas, which is linked to that, that’s generally positive for our export prices. So, yes, not good for the household sector but good for the economy overall, in terms of our income. So you have to think about all of that together. But you kind of gave me an out there. If it’s just the oil price by itself, well, that’s problematic, if it’s persistent, if it leaks into household inflation expectations and businesses. But then, if demand is weaker, generally that’s going the other way. So you’d have to weigh all those up, and that’s the sort of thing the Board does every time it sits down and considers the forecasts. We’ll be doing that soon. Thank you.