The Reserve Bank says a rise in the official cash rate this year is “plausible” and it may have to act decisively if supply shocks from Russia’s invasion of Ukraine and other shortages start to lift inflationary expectations in Australia.
In a speech to an Australian Financial Review summit on Wednesday morning, the RBA governor, Philip Lowe, said Australia’s economy was relatively well-placed to ride out the war-related supply disruptions because the country exports “many of the commodities whose prices are rising”.
Despite financial markets and some economists predicting the RBA will raise its cash interest rates from a record low 0.1% as soon as July, if not earlier, Lowe reiterated that the bank was in no hurry to move.
“The recent lift in inflation has brought us closer to the point where inflation is sustainably in the target range [of 2% to 3%],” he said. “So too have recent global developments. But we are not yet at that point.”
With wages picking up, “it is plausible that the cash rate will be increased later this year”, he said, adding that the invasion of Ukraine had added to uncertainties.
There are two issues that could prompt the bank to move earlier: the persistence of supply-side shocks from the Covid pandemic, the extent “developments in Ukraine add to these supply-side inflation pressures” and how labour costs in Australia evolve.
“Prior to the war in Ukraine, there was some evidence that the supply-side issues in the global economy were gradually being resolved,” Lowe said.
“This new supply shock will extend the period of inflation being above central banks’ targets,” he said. “This runs the risk that the low-inflation psychology that has characterised many advanced economies over the past two decades starts to shift.
“If so, the higher inflation would be more persistent and broad-based, and require a larger monetary policy response,” Lowe said, adding that any shift in inflationary expectations would be “critical”.
“The Reserve Bank will respond as needed and do what is necessary to maintain low and stable inflation in Australia,” he said, underscoring the bank’s readiness to lift rates faster than planned if necessary.
As for wage growth at home, the latest data indicates the rise “remains modest”, he said. The wage price index increased by 2.3% last year, with the broader measure including bonuses increasing by 2.8%, or less than the headline consumer inflation rate of 3.5%.
“The RBA’s central forecast is for growth in aggregate labour costs to pick up further as the labour market tightens,” Lowe said. “This pick-up is likely to be gradual, though, given the multi-year enterprise agreements, the annual review of award wages and public sector wages policies.”
As a major commodity exporter, Australia’s economy would benefit from rises in prices of oil, wheat and other raw materials.
“This means that our terms of trade will rise over the months ahead, which will provide a boost to our national income,” Lowe said.
Still, rising oil prices “will eat into household budgets, push up costs for many businesses and crimp spending in some areas”.
“Given this, I expect that most of this extra national income will be saved, rather than flow through into higher spending,” Lowe said.
Gareth Aird, CBA’s chief economist, said Lowe “sounded closer to raising interest rates than at any other time over the pandemic”.
CBA is sticking with its forecast that the RBA will start raising its cash rate from June.
“The RBA Governor made it crystal clear that the RBA do not need to see two further CPI prints before raising the cash rate,” Aird said in a briefing note.
