Transcript of Question & Answer Session Inflation and Monetary Policy

Nadine Blayney

Thank you, Philip Lowe, and welcome, and thank you to all in the room. We will be taking questions both from people in the room and those that are coming in virtually, as of course it's 2022. Let's start in the room though, just right here.

Swati Pandey (Bloomberg News)

Good morning, Governor. Swati from Bloomberg News. You raised interest rates by, 25 basis points in May and followed that up by 50 basis points in June. Can we expect 75 basis points in July? Is there a need for a larger than 50 basis point increase – is it on the table – and what is the likelihood of that? Thanks.

Philip Lowe

The Minutes of the Board meeting are coming out later this morning and in those Minutes you'll see that we discussed the possibility of a 25 basis point increase or a 50. In the end, we decided on a 50 basis point increase because of the upward revision to the inflation outlook and the recognition that interest rates were still very, very low for an economy that was experiencing high inflation and had such low unemployment. I would expect that we would have the same discussion again at the next meeting. As I said in my prepared remarks, we're not on a pre-set path. We're going to look at the data that we have each month and at the level of interest rates and the inflation outlook, but I expect that next month we'll be having the same discussion at our Board meeting: 25 or 50.

Swati Pandey

So 75 is off the table?

Philip Lowe

That's your language. I'm saying that's what we discussed last time and we will discuss that. That Board meeting is t still a couple of weeks to go, so other things can happen, but at the moment I think that will be the decision we'll be taking – either 25 or 50 – at the next meeting.

Guest

Thank you, Governor. I guess thank you on behalf of Australians, in the first instance, in terms of how you've communicated over the last couple of years; we really appreciate that. A bit of a double-barrel question. You spoke about the tension between global and domestic factors around inflation. I'm curious as to what sorts of conversations occur with other banks in terms of, I guess, a coordinated global response, or is this purely a domestic play that you're looking at? Secondly, could it also be said that monetary policy is more potent these days, given balance sheets, given all the factors that you've just discussed?

Philip Lowe

Perhaps I'll take the kind of international question first, as tomorrow night I'm going on my second overseas trip this year back to Switzerland to have a meeting with the central bank governors to discuss this set of issues. When I was there in May, there were two broad streams of thought. One is that the high inflation is cutting into people's real incomes. We see this here, but in the United Kingdom, it's particularly noticeable; their inflation is going to be above 10 and incomes may be rising 4 or 5, so that's a cut in real income of 5 or 6 per cent. Now, that really hurts people, and that's happening in many advanced economies at the moment. So some people are of the view that this cut in real income is going to crimp household spending, the economies will slow and perhaps unemployment will rise and inflation will come down fairly quickly. That's a pretty negative view of the world. The other view is that the supply-side problems in a global economy can resolve and are resolving, and that oil prices aren't going to keep going up at 66 per cent a year – maybe they'll stabilise, or let's hope they come down – and that that will change the inflation dynamic. and that households, like in Australia, that have built up big buffers, will be able to smooth through this period of a hit to their real incomes. And that inflation can come down without the unemployment rate going up too much. So they are views that people are talking about in the financial community and, when you hear people discuss them, they both seem plausible. I think this is one of the reasons why markets are volatile at the moment, because we're all having trouble working out which of those views is more likely to represent reality. I'm sure, when I go there this weekend, we'll be discussing the same set of issues. You asked, in the second part of the question, whether monetary policy is …

Guest

A lot more potent.

Philip Lowe

I wouldn't say that it's more potent, but I think it will be potent. Right at the start, the first increases in interest rates that we've done really haven't affected most people's mortgage payments that much because people have built up big buffers and many people were paying more than they needed to. So, at the moment, the higher interest rates have not had a really first-order effect on most people's mortgage payments. Clearly, they've hurt some people, but broadly it hasn't had a big cash flow effect. But, as interest rates start to rise, those buffers will be eaten into and the fact that households have more debt than they used to, it will start to bite, and we're very conscious of that. When that point is, it's going to be hard to tell because we've got more financial assets as well. $200 billion of extra savings, that's a lot of money. So that's sitting in offset accounts and it's sitting in deposit accounts. So there are a lot of kind of moving pieces here, and that's why I drew attention in my prepared remarks to the fact that we're monitoring household spending very carefully. But where we stand today, household spending has been pretty resilient.

Guest

Thank you.

Nadine Blayney

Richard Edward.

Edward Boyd (SkyNews)

Governor, Edward Boyd at SkyNews. It's looking likely that America will fall into recession next year and New Zealand has just recorded a quarter of negative GDP growth; it's pretty clear that these economies seem to be a bit ahead of us. How likely is Australia going to fall into a recession; how likely is that?

Philip Lowe

Well, I don't see a recession on the horizon here. Right at the moment, our unemployment rate is the lowest it's been in 50 years, the participation rate is the highest ever, more working-age Australians have jobs than ever before, the number of job vacancies is at a record high. Households have strong balance sheets. Our terms of trade – this is our export prices relative to our import prices – are at the highest ever. When we had the resources boom a decade ago, I used to say, 'Well, they're the highest since 1848, when we had the gold rushes in the British colonies'. They were then the highest since 1848, yet here we are today, in 2022, having a higher terms of trade, which is really boosting our national income a lot. So, Australia has a lot of positives and so we don't see a recession on the horizon. But if the last two years have taught us anything, you can't rule anything out. But our fundamentals are strong, and the position of the household sector is strong and firms are wanting to hire people at record rates; it doesn't feel like the precursor to a recession. And interest rates, while they've gone up, are still low. The cash rate is still less than 1 per cent, at a time when the unemployment rate is at a 50¬≠year low. So the fundamentals here are still pretty positive.

Nadine Blayney

Governor Lowe, will the unemployment rate need to rise to really get that inflation rate back within the target band?

Philip Lowe

I don't think it needs to rise but, at some point, it may rise. It's quite possible that inflation comes down because oil prices don't keep rising, supply-side problems get resolved and we get a better balance between supply and demand in the economy. But it's a fairly narrow path that we're on. We're trying to get demand and supply to increase at the same rate, and achieving that is difficult. So it's quite possible that at some point in time the unemployment rate will rise, but I don't think it needs to rise. I'm hoping that we can get inflation back to 2 to 3 and keep the unemployment rate roughly where it is.

Nadine Blayney

That brings me to a question that has come in from online. This is from Ronald Mizen (The Australian Financial Review). He says, 'You've updated your forecast for peak inflation over the past week, which you've discussed. What is your forecast now for when underlying inflation will return to that target band?' So he is looking for a timeline.

Philip Lowe

It's a couple of years away. We have not yet done a full update of our forecasts following the May update. The new headline inflation forecasts were really done kind of mechanically from higher oil prices and higher electricity and gas prices, so in the next month or so we will be doing a full forecast update. But it's going to be some years, I think, before inflation is back in the 2 to 3 per cent range but, over the next couple of years, it will gradually come down. That's why it's important that we chart this path back there and that people have confidence that we'll do that.

Nadine Blayney

Sarah Hunter, KPMG. If we could get a microphone …

Sarah Hunter (KPMG)

Thank you, Governor Lowe. I wanted to ask you a bit more about what you talked about with the balance of demand and supply and wanting to get the two to grow together with a low, stable inflation rate and how you see the monetary policy settings and the path for the interest rate interacting with the fiscal policy settings. Particularly, thinking about some of the fiscal supports that are going to start to hit households from 1 July, whenever people start doing their tax returns.

Philip Lowe

I guess you're referring to the LMITO payments that people will get which will help household spending. But I'm not concerned about any misalignment between monetary and fiscal policy here. I understand why the previous government and the current government want to provide some support to households, particularly those most affected by the higher cost of living; so that's understandable. The higher interest rates, as I said in response to an earlier question, will slow some forms of spending. I think we need that because, at the moment, the growth in spending in the economy is putting too much pressure on the ability of the economy to produce goods and services. So higher interest rates are part of the way of getting that better balance. How high we need to go is still to be determined and I don't have a crystal ball here. You've got both demand and supply sides. Interest rates affect the demand side in a relatively predictable way, but the supply side, as we know, can be subject to big shocks. So how to get that balance right is our challenge, and it is a challenge. But I'm not worried about any misalignment of monetary and fiscal policy; the bigger challenge for us is getting demand to grow along with supply.

Nadine Blayney

Next question. Tim?

Guest

Governor, thanks for that speech; you covered a lot of ground there. I just want to think about pre-COVID, when interest rates were at 75 basis points. Fast forward to today: we have a market pricing in 375 as a cash rate target, 4¼ for early next year. I know that you've said there is no pre-set path, but you've spoken a few times about 2½ per cent as being a neutral level. To what extent do you think current market pricing reflects a reasonable trajectory for interest rates, or is it down to the reputational damage that you think coming out of yield curve control might have done?

Philip Lowe

I don't think the current market pricing is a result of the way the yield target was managed. At the moment, current market pricing is for the cash rate to be 4 per cent by the end of this year. To get to 4 per cent, we would have to increase interest rates at 50 basis points at the remaining six meetings for this year and have a 75 basis point increase in there as well. I'll leave it to others to opine on whether they think that's reasonable, but I would observe that would be the sharpest and quickest tightening of monetary policy that we've ever experienced in the inflation targeting regime. I'll leave it to others to come to a judgement of whether they think that's reasonable. An increase in interest rates of that magnitude, I think, would have a first-order effect on consumption, it would affect people's mortgage payments, it would affect confidence and I think it would slow the economy quite a lot. So I don't think it's particularly likely, but the market has been a better judge of where interest rates are going than we have over the past few years, so we've got to pay attention.

Nadine Blayney

There's another question at the back of the room.

Guest

Governor, on the issue of household balance sheets and the ability to absorb interest rate increases, at the other end of the spectrum from those who have built up buffers, the April Financial Stability Review estimated that a 200 basis point rise in mortgage rates would see an increase in the share of borrowers facing higher repayment burdens being those with a debt service ratio of greater than 30 per cent, rising from 10 per cent to 20 per cent. On that question of market pricing, 300-basis-points from here, when we've already returned to a cash rate that's at pre-pandemic levels, is there a level at which the RBA would be concerned about borrowers with higher repayment burdens that the Board would be uncomfortable with, and is it reasonable to see this level increasing relatively rapidly?

Philip Lowe

We'll, as I said before, we'll be watching household spending very carefully and we know that while the median borrower has built up big financial buffers, there are a group of borrowers who have very skinny buffers. People who have taken out their first housing loan in the last year or so or who have bought a bigger house in the past couple of years and have borrowed as much as the bank would lend them. Those people have fairly skinny buffers. We're very conscious of that, and we'll be watching that part of the loan distribution very carefully as we raise interest rates. There's no particular cut-off where it becomes a problem; but we'll just be monitoring it very carefully, as we know that the averages can hide a lot of variation and not everyone has built up these big buffers. The median borrower has a buffer well in excess of a year's mortgage payments; some people have it for two years of mortgage payments. But there is this tail of people who aren't in that position. So our job is to monitor the whole distribution and assess how it's going to affect overall consumption. But there's no critical point where it becomes an issue.

Daniel Sutton (Channel10)

Hi, Governor. Daniel Sutton from Channel 10. Thank you for the speech. I've got a two-part question, if that's okay. Firstly, the Treasurer has indicated, we read, that he's going to move ahead with an independent panel review into the RBA. I wonder what your response to that is and are you worried about what it might dig up? The second part of the question is a personal one. I wonder: you've been at the RBA for a long time but as Deputy Governor and Governor, this is the first time that interest rates are going up. I wonder whether you personally worry about the misery that the decisions that the RBA takes may end up inflicting upon people at home. Does it keep you awake at night?

Philip Lowe

Good questions. On the review, both the Board and the staff welcome the review. It's an opportunity for us to hear from others. It's an opportunity to learn and to hear people's perspectives, and it's an opportunity for us to respond on some public policy issues as well. I'm not worried that it's going to dig up anything. It's an opportunity to learn and, at the Bank, we've got a very strong learning mindset and the fact that we're producing what I hope you view as an open review of the yield target this morning, and we'll do further ones like this. Our mindset is to learn and make sure that the monetary policy arrangements in Australia are serving us as we go forward. So we welcome it and we will work constructively with the government on it.

At a personal level, I'm proud in a way that the country has got to close to full employment. You know, the unemployment rate is the lowest in 50 years and, as I've said, a higher share of the population has a job than ever before. And having a job is the best thing for people, even young people, it gets them on the ladder of opportunity and, once you're on that ladder, you can take further steps. So I take pride in the fact that the Bank has worked with the government to get the unemployment rate to as low as it is. I know businesses don't always welcome that, because it's harder to get workers, but, for the overall welfare of the society, people having jobs is tremendously important. As interest rates go up, some people are not going to be happy about that. But I know that other people will be happy because, in the nearly six years I've been the Governor, I've seen so many letters from people complaining that low interest rates are making their life a misery. There is a segment – in fact, a sizeable segment – of the population who have been hurt by low interest rates. So our job is to kind of balance the people who don't like low interest rates with the people who want low interest rates. As an individual, I'm concerned about the people who borrowed too much and who could get themselves into trouble and so a constant message right through the last few years has been to make sure that you have buffers; be prepared, the future is uncertain. So some people will have problems and, as an individual, that saddens me. But I take pride in the fact that this country is closer to full employment than it has been in 50 years, and that's important.

Guest

Thank you.

Nadine Blayney

I think you sleep as well as anybody else in the room may or may not. Let's go to a question that's come in online. This is from John Kehoe from The Australian Financial Review asking what impact do you think that the minimum and award-rate wage rises that came through last week from the Fair Work Commission for the 2.7 million workers will have on wage and inflation psychology? Is there a risk, he asks, that we will return to the 1970s?

Philip Lowe

Well, I certainly hope not, and I don't want to comment on that particular judgement. Just to refer to a medium-term point that I've been making for some years, and I think it remains relevant, over time, we want to deliver you an average rate of inflation of 2½ per cent. If the country can generate labour productivity growth of 1 per cent – I hope we can do at least that – if we can generate labour productivity growth of 1 per cent that means that labour costs in the steady state could grow at 3½; 2½ per cent for inflation and 1 per cent for labour productivity growth. I'd been concerned for a number of years that the rate of wage growth that we had previously in the 2 to 2½ per cent range was too low, meaning that it was going to be hard for us to achieve the inflation target and it was diminishing the society's sense of collective prosperity. I'd been speaking about that quite a lot. I just think it's important to remember that the steady state wage increases in Australia should be around 3½ per cent. We can have increases in some parts of the labour market bigger than that for a short period of time. But, if wage increases become common in the 4 and 5 per cent range, it's going to be harder to return inflation to 2½ per cent and then we'd be in a world where the economy would have to slow more and perhaps the unemployment rate would need to rise. I think people, if they can keep in mind that, with steady state wage increases in this country, it's good to start with a 3. I was complaining when they started with a 2. I hope that I don't get into an environment where I'm complaining that they have a 5 in front of them. But 3½ is kind of the anchoring point that I want people to keep in mind and I know it's difficult when inflation is higher than that, but, in the 1970s, we got into trouble because wages growth responded mechanically to the higher inflation rate. We had higher inflation and wages responded, and then that becomes persistent, and then you have to have higher interest rates and a downturn to get inflation down. I'm hopeful that we can avoid that, but it's an important issue. 3½ is better than 2 and better than 5.

Nadine Blayney

Perhaps we'll go to the back of the room first.

Lewis Jackson (Morningstar)

Good morning, Governor. Lewis Jackson from Morningstar. I'd like to ask you about how you think about the risks of overtightening. You know, we've seen markets get quite (inaudible) about growth over the last few weeks. The Federal Reserve last week cut their employment and growth forecasts. How do you think about the risk that could happen here?

Philip Lowe

You're really asking about whether we're at risk of making a policy mistake, and I'll let other people kind of opine on that. But it's a fairly narrow path partly because of the uncertainty about the external environment. As I was saying in response to the question about international discussions, there are two quite plausible scenarios out there about how the inflation outlook evolves. Will the cuts in people's real incomes cut their spending and lead to a slowing of the economy and a rise in unemployment? That's possible. I think it's not particularly likely, but it is possible. But it's also possible that inflation comes down, for the reasons that I've talked about, and we can keep this very low level of unemployment. When there are all these uncertainties, it's highly unlikely that we'll get it exactly right. We'll make mistakes, and I hope the mistakes are not too large and we can kind of self-correct. Probably the last point to make here is that, because of all these uncertainties, we're monitoring things incredibly carefully, including spending patterns and how people are going with the rate of mortgage payments. At the moment, the number of people who are falling behind on their mortgages is declining; it's still fairly low and it's much lower than in many other countries. So, you know, there are a lot of moving parts and, when there are a lot of moving parts, you're not going to get it exactly right. But the Reserve Bank Board meets every single month and we self-correct hopefully when things turn out differently, as we've done during the pandemic.

Nadine Blayney

Sarah, I think you had another question.

Sarah Hunter (KPMG)

Thank you, and thank you for letting me have a second question. I want to pick up a bit actually on the question from John Kehoe around inflation expectations. You mentioned in response to an earlier question that you think inflation is going to be above 3 per cent for a number of years; a couple of years, I think you said. How do you see that then feeding through into inflation expectations and are you worried about them becoming anchored at a higher level, to your point on wanting wages growth to be 3.5 and not leading with a 4 or 5?

Philip Lowe

Am I worried about it? If inflation expectations did start moving away from the 2 to 3 per cent range, I would be very worried about that, because the way to get them back to the 2 to 3 per cent range would be a slower economy and even slower wage growth to bring inflation down. So, if the inflation psychology shifts and people start expecting inflation rates in the 3s and 4s and higher, we'll have problems. I'm not particularly worried about that happening at the moment. Inflation expectations, at least measured in financial markets, are still well anchored in the 2 to 3 per cent range. I hope most people understand this is a spike in inflation largely due to COVID and the terrible events in Ukraine and the insurance that was taken out during the pandemic. The insurance is being unwound, the COVID supply problems are being fixed up, and who knows what's going to happen in Europe. But people should have confidence that inflation will come down again. Financial markets have that confidence, and I hope Australians have that confidence as well. If that confidence were to slip and the whole inflation psychology were to move up, then we'll have problems, so it's best to avoid that. And higher interest rates, while they're uncomfortable for many people, are part of that, of sending a strong message that inflation will come back down, we will do what is necessary, and we're not going to let inflation persist at these very high rates.

Sophia Rodrigues (Central Bank Intel)

Sophia Rodrigues from Central Bank Intel. You say in your speech that higher interest rates have a role to play by helping ensure that spending grows broadly in line with the capacity to produce goods and services. How does that actually work? You said earlier that the unemployment rate doesn't necessarily have to go up; so, if spending has to slow, how can it slow and the unemployment rate not go up?

Philip Lowe

Well, the rate of spending growth over the last six months has been strong enough to get the unemployment rate to come down a long way, hasn't it? We're at 3.9 per cent, and the number of job ads at the moment is extraordinarily high. So, the demand in the economy at the moment, the way that it's been growing has been strong enough to get unemployment down. So it's quite possible to have slower growth in demand and growth in demand for labour matching growth in labour supply. I acknowledge that there are risks that the balance here doesn't turn out to be in perfect balance, but it's certainly technically possible to have higher interest rates, slow spending and spending slow to a point where growth in labour demand matches growth in labour supply. There are uncertainties there, but it is possible.

Nadine Blayney

Yes, we live in a world of possibilities. Governor, you mentioned that you expect to see a slowdown in spending – this is from Shane Wright (Sydney Morning Herald) – as interest rates increase. Which areas of spending do you believe will be affected first to perhaps the most?

Philip Lowe

Well, the most interest-sensitive parts of spending are spending on housing – so housing construction is quite sensitive to the interest rate cycle – and spending on consumer durables is also typically quite sensitive to the interest rate cycle. But it's complicated at the moment because over the past two years people have bought a lot more stuff for the house. People were sitting at home, kind of wanting to fit out their home office and kind of decorate their home, so there's been a lot of spending on consumer durables. So that's the other complication at the moment, that there could be some recalibration there at the time of higher interest rates. But, historically, its housing spending and spending on consumer durables, and we're watching those very carefully.

Nadine Blayney

We're almost out of time. Is there another question from the room?

Guest

Thanks, Governor Lowe. Just picking up on your comment that we're nearly at full employment and you're not expecting the unemployment rate to rise as interest rates move up. Given a range of indicators – whether it's the unemployment rate, the underemployment rate, the inflation polls, survey data on availability of labour – might suggest that we're beyond full employment and I would interpret financial market pricing of a cash rate of 4 as suggesting that we're beyond full employment, and that's why rates have to move up. What's driving your assessment that we're not quite there – that we're around full employment rather than beyond it – and what are the risks that we have gone beyond it, we pushed too hard and have to catch up?

Philip Lowe

Well, it's a good question and there's quite a degree of uncertainty around what constitutes full employment in our economy. It may be the case that we've gone further than is sustainably achievable. But I am conscious at the moment that the labour market has been in a sense of dislocation because many people have not been able to work. I know that, in my own organisation, a lot of people can't come to work because they've got COVID or they're looking after a family member who has got COVID. So the labour market has been in a state of dislocation because of COVID. That leads to a very strong demand for workers because, if 5 per cent or 10 per cent of your workforce is away, you need extra workers, and so there's extra demand. So I don't think we'll know what full employment looks like until we're through the kind of COVID-related absences. It's very disruptive for many businesses and it has led to shortages in parts of the economy, and we won't know what full employment looks like until after that's behind us. It's possible that we've gone too far, but I'm hopeful that we can, in Australia, sustain an unemployment rate of around 4 per cent, have inflation of 2½, 1 per cent labour productivity growth and 3½ per cent on wages. That would be a good outcome, wouldn't it?

Nadine Blayney

With one minute left, I will be cheeky and ask you one final question. Thank you for all the questions from the room and online. Dr Lowe, the business liaison program provides a wealth of information, and often times we live for long periods between getting official data. Is there any consideration given to sharing more openly and transparently, the information that comes from that liaison program on a regular basis?

Philip Lowe

We do share it on a regular basis in the quarterly Statement on Monetary Policy. Each time that comes out – the next one will be in August – we highlight the key themes from that, so that's what we currently do. Sometimes, as occurred last month, we highlight in it speeches or press conferences that I give. So I'm not sure exactly what more we can put out on business liaison, but, if people have good ideas, we're open to them. At the moment, the model is to talk about it in the Statement of Monetary Policy every three months.

Nadine Blayney

Thank you.

Philip Lowe

Thank you.

Richard Yetsenga

Thank you. I'll just finish very quickly. We came together today under the auspices of the American Chamber of Commerce and Australia – thank you, Doug, for the partnership – to listen to Governor Philip Lowe discuss inflation and monetary policy and also reference today's transparent review of the yield target, and thank you for your generosity with your time and openness in the Q&A. Maybe, for me, the key takeaway is that the RBA recognises the inflation challenges that I think we all see in our personal and professional lives; 7 per cent inflation in the December quarter is a number that you've mentioned publicly recently and repeated again today. Inflation is damaging to the economy and is regressive, so we do need to return it to target, but it doesn't need to happen tomorrow. There's a strong commitment to return it to target and, for that to happen, spending will need to slow, so I think the implications for interest rates are very clear. Look, a message to you, Governor and your team at the RBA, a very 'challenging' time – a word that you've used quite often – with lots of forces operating, as you work extremely hard in the public eye to deliver into your mandates. We do wish you all the best of health as you go about this important work. Thank you. Thank you, everybody.