Transcript of Question & Answer Session The Restrictive Stance of Monetary Policy

Thank you, Chris, for the presentation, the update on financial conditions, and welcome everyone to this Reuters NEXT Newsmaker interview. I’m just going to dive straight in. I want to bring our audience back to two days ago when the RBA held interest rates for the second time this year after three rate hikes. Governor Michelle Bullock came out super hawkish. Just to give a little bit of context to our audience, she did say that the Board considered an interest rate hike, and that she personally thought it is quite possible that rates might have to go up again. And I think a lot of people find it quite jarring from the statement itself and also the updated forecast from the staff, which had inflation going back to the target sometime next year. I’m just wondering, Chris, if you can just help us understand what’s causing the tension here?

Sure. I think the first thing I’d highlight – and I used to say this a lot, particularly when I was the Chief Economist, and I would refer you to the fan charts on the forecasts – the uncertainty going out over the horizon at which monetary policy has to focus, which is a year to two years or so, there’s so much uncertainty out there that places, I think, the small revisions in context, and it reminds you that the revisions that were made to the forecast were pretty small.

The thing that the Governor emphasised, and the statement and the media release emphasised, I think, is the uncertainty and our sense that the various risks that we called out, we think they’re leaning very much to the upside when it comes to inflation.

Another way of thinking about that is our central forecasts have inflation declining a touch more in trimmed mean terms than the previous statement – but I’d emphasise a touch – but a lot of things still have to go right for that to come to pass. So, one of the things that has to go right is the Strait of Hormuz has to open up in reasonable time, for example. Another one that has to go right – and it’s not so much a forecast as much more an assumption – of productivity growth picking up, because productivity growth has been very disappointing, and our forecasts have a modest pickup, but it’s still a noticeable pickup. So, if that doesn’t come to pass, other things equal, that makes the job of bringing inflation down that much harder.

So the Strait of Hormuz and productivity, that’s the–

Those were the two I would call out. There are others, though.

And the other thing, I guess I just want to press you a little bit on the communication from the Bank. I know Governor Bullock doesn’t do forward guidance, but I think a lot of people were saying, oh, she was basically giving forward guidance. Do you think that’s true, or is it just typical central bank jawboning to help manage expectations here?

No, look, I think she was being as transparent as she could to note that the tone of the conversation in the Board meeting was very much concerned about those upside risks, and that concern suggests that there is that possibility of rates going up further if some of these adverse things that I mentioned come to pass: if oil prices stay high or move higher, if productivity growth disappoints, if other things that are sort of on the side that’s helping global growth remain quite resilient, if they stay strong. All of those things, if they come to pass without some adverse things at the same time, then the possibility is that the Bank may have to raise rates further.

I also want to ask you about housing, but I see you already–

Please, it’s a favourite topic.

Yeah, I know, but I’m just going to – it’s just this question that I have: the housing market has weakened quite a lot lately, and a lot of economists, they’re calling for like double–digit drops in home prices this cycle, which clearly suggests policy is on the tight side, but consumer spending has held up quite well. I’m just wondering, how do you reconcile these two signals here?

Well, not everybody who consumes, obviously, has a mortgage, so maybe that’s part of it. We have still had a reasonably – despite some softening – the labour market in context is still a little on the tight side of things, and the unemployment rate has moved up a bit, but it’s still around quite low–ish levels in the scheme of things. I think that might be part of it. I think the other thing is, look, housing prices have declined, but they had also come off very high levels. And, look, it’s very hard to know. When you run models and do estimates, it does seem that declines in housing prices – rightly so – have some effect on people’s willingness to spend. So maybe that’s to come. That’s one of those sort of downside risks that we’d call out. But put it in some perspective as well, and you look back at the sorts of growth we’ve had in housing prices, the sorts of declines that we’ve seen, even in Sydney and Melbourne, are sort of bringing house prices back to where they were only a short while ago. So maybe that’s part of the explanation.

I want to turn to markets, which is your area. There’s this global push towards 24-hour trading on major stock exchanges – I think our friends LSEG here are planning something next year – which could mean more volatility if the liquidity is not there. Just given how concentrated the market is right now and the volatility we’ve had this year already, does that worry you as a central banker?

Not particularly. I mean, one possibility is if there is that sort of move to trading for more hours of the week, the possibility is that there are some in markets that are active and awake that otherwise would not be. So volatility that might occur in our region – because many parts of the world have either just gone to sleep in the US or heading that way, or left the office at least, and Europe and parts of Asia even haven’t yet woken up – maybe some of that volatility, at least in our region, might be diminished. So it’s not – I don’t think it’s immediately clear just because you have more trading through a 24–hour period that it’s necessarily going to increase volatility. It’s hard to say.

If I can just follow up, are you concerned, just given the concentrated market with technology stocks, is there any concern about an AI bubble?

Well, look, these things, like many assets, are very hard to value. And some of the valuations in equity markets just generally do seem fairly generous. I sort of touch on that in my remarks by just noting that risk premia remain at historically pretty low levels. So there is always the possibility of some sort of correction. And then the question though is, I think: is that correction just responding to, let’s say, macro developments that might warrant a correction, and therefore they’re not amplifying anything, they’re just mirroring what’s happening in the real economy, and therefore they don’t necessarily have a particular concern? Or do they get their own head of steam going, particularly if there’s an unwinding of a lot of leveraged positions? So I think that’s always the bigger concern in markets. So that’s why traditionally you have been less worried for central bankers about unwinding of market positions which don’t have a lot of leverage, typically the equity market, but that’s not true everywhere, and it’s not true of all equity markets in every form of trading.

What about Aussie bond markets? We know there’s a lot of foreign issuers coming down under here to issue kangaroo bonds, what’s driving them here in your assessment?

Look, I think they come here and they appreciate the strength of the market infrastructure that David referred to earlier, the legal framework, the regulatory framework, very transparent markets. And I think they’ve just found that it’s a good place to diversify in terms of sources of funding to come here. And it’s been very beneficial, I think, for the Australian financial system, including for banks and the like, Australian banks who raise funds offshore, for exactly the same sorts of reasons: to diversify their funding base, to make sure they’re getting funding at the lowest possible cost, because that means there’s a more of a natural hedge going back the other way when they want to hedge their exchange rate risk. So I think it’s a very good thing.

And do you think this has to do with the diversification away from the US dollar?

I’m not so sure it’s specifically that. I mean, this has been growing over a period of time. I think just as markets grow, they can build a bit of momentum because there are more people who are more familiar with it, and more investors come here to pick up these bonds, and more issuers think this is a good place to issue for various reasons. And so you get a bit of growth, and the growth then begets more growth.

I just want to follow that up. What does it mean for your reserve management? I think I saw in your annual report that you reduced the dollar holdings but increased the allocation to the euro last year. I’m just wondering, what’s behind that? And would you be looking to hold more emerging market currencies in your reserves?

We hold currencies that we deem to be highly liquid. So, there’s no pressing move to sort of expand into other currencies. We hold these for policy purposes in case we ever decide there’s a need to intervene. The change that you refer to just reflected that from time to time we look at our benchmarks and we review those, and we thought we were a little bit long on the US dollar at the time, so there was just a small change in our allocation. But I’m one of the first people to say you can’t really predict exchange rates and where they’re going. So it wasn’t really based on some deep insight because I don’t have any deep insights on exchange rates, other than: don’t predict where they’re going.

I also saw you have 5 per cent, allocation to Chinese yuan? Is that– would you be looking to increase holding of that?

Oh, look, we’d announce in time if we made changes of that sort, again, in our annual report. I mean, that’s just been part of our strategy to diversify. It’s very helpful also because once you invest in a currency like that, it enables and forces you to better understand not just the real economy, but also the financial economy. And as a major trading partner, I think that’s a very valuable thing for us and has been for some time.

My last question is about the Aussie dollar. I know you – because you mentioned some of that in your presentation, but like, I think we track the Aussie dollar every day. It has been pretty boring, to be honest. So it hasn’t – it has been trading in a narrow range of like 5 cents since the war started, uh, in February, March. So it doesn’t really seem to be correlated to commodity prices any longer. It’s not even a risk barometer these days. Just like, what, what is it?

Uh, yeah, I’m not so sure. I, I would say that part of maybe what you’re observing is the fact that commodity prices have been reasonably stable and quite resilient and maybe held up a bit more than people might have thought. And I’m not just talking energy because of the conflict in the Middle East, but you can look at iron ore, for example. Now, actually, iron ore prices have slipped a bit in recent months, and I do think that’s partly having an influence on the Australian dollar. But probably the bigger thing, as I pointed out in my remarks, over the course of this year has been the fact that we’ve tightened monetary policy more than others, and so it’s natural to have seen the Aussie exchange rate appreciate. It’s come back a little bit in more recent times as markets have recalibrated their expectations for our policy rate versus others, but I think the theme this year has been that appreciation reflecting the interest rate differential. So, our models, which have the interest rate differential and the commodity prices, say the exchange rate’s still behaving more or less as you might expect, driven by those you know, according to those basic forces.

I’m just going to ask one last question before we open up to the floor. So, I think the RBA said a few months ago it was studying a new monthly underlying inflation gauge, because we’ve got the monthly CPI data now. I’m just wondering, do you have any progress that you can report on that, and when are you looking to shift to monthly away from the quarterly data?

Yes, so this is not my area of expertise. I think the thing I can comment on is that we have long wanted a monthly inflation measure, so it’s very welcome. The thing about it is, one, it’s very useful, and as someone who likes data and statistics, you’d never throw away a potentially useful piece of information. I think it is particularly useful. I think what we – the situation we find ourselves at the moment is though, one of the things we look at quite closely is trimmed mean inflation. We find that’s a useful barometer of the longer, slightly longer–term trends on inflation. And the issue with the monthly trimming is we don’t have a long history of that, and so it’s hard to do a seasonal adjustment on the monthly. You need a history of some time to develop what those seasonal factors are on a monthly basis. So until such time as we’ve had enough of that history of monthly data, it’s at the margin less useful than it will be in the future. Still, it is still useful.

Statistically, how much data, monthly data, are you looking for then?

That’s a good question. I think the ABS are the ones you’d really have to ask. I think it’s a few, a few years. You typically need about 3 years’ worth of data to help start to form seasonal factors.

And you were asked about holdings of yuan. What about yen? Why didn’t you increase yen, or would you increase yen?

Uh, look, it’s always an option. I think we do our best to sort of think about the risk–return and having a balanced portfolio, and our judgment was that it was worth moving into the euro at the time.

I have a question about the new legislated capital gains tax. How do you discuss that at the Reserve Board meetings, Bank meetings, the impact on allocation of risk capital for increasing productivity and jobs?

At the margin, but I mean, it is a topic of discussion because those are very important things, as you say. Investment, productivity, employment. However, and I think the Governor responded to a question that wasn’t too dissimilar to that, we are not tax experts, so we rely a lot on the Treasury advice, and we look at what others are saying out there in the community who are more expert at those things. And I think there’s still considerable uncertainty about the effects of those things.

Hi, Chris. I have a quick question for you. What in your role, what keeps you awake at night?

What I’ve been doing? I’ve been in this role for a while. Not a lot. I sleep pretty well. I think – I mean, there – I’m very good at, and it’s sort of my job as an economist – when particularly, let’s say, I might be having a conversation with somebody who’s sort of telling me about their view of things, which might be in my mind a little bit skewed to one side. And then I’m going to be very good at telling you all the other things that can happen in the other direction. I think as humans it’s quite natural to focus a lot of times on negative things and things that can go wrong. And it is often true in economics, when things do go wrong, they go wrong quite quickly and quite noticeably. But when things go right, it’s often because of an absence of bad things happening over a period of time. So yeah, look, I sleep very well.We talked about the, the risks already, and I think the risks that the Board are focused very much on is that a few of the sorts of things in our forecasts, quite a few of those things have to go right in order to ensure that inflation does come back down. Now, some things could go wrong in terms of hits to global demand or domestic demand that might do some of that job for you. The other concern, of course, is things like the shock we’ve seen in the conflict in the Middle East. That’s a very challenging circumstance, particularly for monetary policy, because it worsens very much the trade–off between unemployment and inflation. So, I guess I worry about those sort of things we don’t focus on that build over time that makes the task of achieving ow and stable inflation that much harder, and something like the Middle East conflict is one of those.

Hi, Assistant Governor Kent. Just interested more keenly on your area of funding markets, where, you know, clearly you’ve contributed vastly to the stability of Australia’s funding markets in the last few years. In light of that last question, though, is there something that could still be of concern to you on that front, particularly given the concentration of the local banking industry and also the continuing growth of our super funds?

There’s nothing specific. I mean, I think on the one hand, we do need to recognise we’re a small, open economy, and what happens globally is something that can have significant effects on the Australian economy, whether we like it or not. The important thing, I think, is to have mechanisms to respond in as flexible and a quicker way as possible. And our biggest sort of thing that comes to mind there is the Australian dollar. It is very flexible, it is very responsive, and it’s a really important mechanism for us to adjust to external shocks, including if those shocks occur in funding markets. I think one thing that’s not always well appreciated is that if there are stresses offshore that make it a little bit harder, let’s say, for our banks to fund their books from offshore, which they do because it’s a good source of diversification for their funding and at low – at reasonable cost – if that becomes a little bit more strained, a depreciation in the Australian dollar helps tremendously because what they’re doing is they’re raising funds offshore to bring them back to Australia to fund Australian loans that go into Australian investment. So they need a lot less Aussie dollars – sorry, foreign dollars and euros and yen if the Aussie dollar depreciates. So that’s an important buffer.

The other really important thing is all the sorts of things David talked about before: a sound legal system, strong regulators in ASIC and APRA, sound monetary policy, inflation close to target, and a stable economy and flexible product markets, flexible labour markets. Those are the sorts of things we’d need to withstand global shocks.

Hello, Chris. My question was around the economy, and we many a times talk about risks and the weaknesses in economy, but I wanted to get some good news from you on what you think are the strengths of the economy. Where do the opportunities lie, particularly for financial institutions, particularly for super funds?

That’s a good question, but I’m not sure you’ll get the answer from me that you’d like, because I think it is very hard if you think about people knowing where all the best places are to, say, invest and grow. And it’s very dangerous, I think, for economists to suggest that they do know that. So I won’t give you that answer. I think a little bit harking back to the earlier topic, what I would say we need is all of those strong institutions that provide the right foundation and things that can enhance productivity growth just generally, which can be many things that you don’t always appreciate. But essentially it’s flexible labour markets but also flexible and competitive product markets. And businesses like to talk about the flexible labour markets quite often, and then those who have more of a labour focus want to talk about more about competition, but they’re both really important things and they need to come together.

Hi, Chris. Just a question on, I suppose, AI and where that comes in your consideration. So if we looked at forward going, the impact of AI on productivity, but also the possible impact on workforce in Australia.

Well, I think if it’s going to have legs, it’s going to – it’s going to be because it is a very productive tool. The impact though on employment is very hard to know, and I think that’s true of any new technology. I think the bigger concern that most economists sort of voice here is, well, first we don’t know, and second, if there is a transition where it changes the demand for labour, particularly in one industry, it’s a question of how quickly that adjustment takes place, and that can be quite disruptive. And it can be quite disruptive in a way that’s unexpected. So for example, if you’ve got an industry that is likely to be dominated by AI and need a lot less workers in the future, it might mean – that future might not actually realistically occur for some time. But in the meantime, you discourage workers to stay in that industry or even come into that industry. So you can have a lack of supply of workers for a time. So I think it’s very hard to tell. I think it will have important effects. And I just caution anyone going too extreme one way or the other. And the most important thing you can do is think about the transition period. And there may be reasons to look for – trying to think about how people can make transitions, not keep them in industries where they shouldn’t be, allow them to move to other industries. Education is going to be important, but again, go back to flexible labour markets, competitive product markets. That’s really going to be good for productivity in the long run and good for employment and wealth creation as well.

Okay, before we wrap it up today, Chris, I just have one last question for you. So how are you personally using AI? Because we heard from the Governor she’s using AI to invent questions that journalists might ask her at the press conference. But what about you?

Yeah, I was advised by someone in our Comms department that that was a very good prompt to look at your – look at my speech, look at questions recently, and think about what are good questions. I’ve played around with AI for both work and personal reasons. For work, I find it quite helpful to think about, for example, how we in the Bank are managing risk, because I’m responsible for managing the risk that’s on our balance sheet, and just how to think about various different concepts of measuring that risk and different possibilities that might cause us to sort of miss things. And it can be quite helpful if you’ve just got some ideas you want to play with on the side with a little bit of data to sort of generate some examples that might give you reason to pause about what you thought you knew. And then, yeah, I like to study a little bit of Spanish, and I find that you can generate some quite useful apps just all by yourself using AI to help you do that.

I’m afraid that’s all the time we have for today. I think we’re right on time. And thank you so much for being here for this Reuters next Newsmaker interview. And thank you, Chris, for your time today, and see you next time.

Thank you. Thanks, Stella. Thank you all.