RBA Lowe: Upside Risk To Inflation From Global Inflation Shock, Demand Rebalancing

(This article was first published on Tuesday, November 16 at 1:30 PM as an email to premium subscribers)

From Governor Philip Lowe’s speech to the ABE webinar:

--Latest data, forecasts do not warrant cash rate rise in 2022
--Possible faster-than-expected progress is made towards achieving inflation target
-- Still plausible that the first increase in the cash rate will not be before 2024.
--Hard to precisely define meaning of “sustainably in the target range”
--Inflation trajectory, labor market developments important for policy decision
--Don’t have target for wages growth, neither is wage growth only determinant of inflation
--Using wage growth as guidepost for assessing progress to inflation goal
--Current global inflation spike “transitory”, market pricing vindicates this

By Sophia Rodrigues

(Sydney, November 16, 2021)—The current global inflation shock poses an upside risk to Australia’s inflation forecasts if it proves to be more persistent and rebalancing of demand towards services doesn’t ease inflationary pressures, Reserve Bank Governor Philip Lowe said Tuesday.

Lowe made the comments in a speech to the Australia Business Economists webinar titled, “Recent Trends in Inflation.”

Earlier Tuesday, the RBA acknowledged upside risk to its inflation forecast presented in the November Statement on Monetary Policy where it cited two reasons: current disruptions to global supply chains and behavior of wages at lowest unemployment rate in decades.

But Lowe’s comments suggests there is more upside risk that those discussed in the minutes.

In the speech, Lowe talked about the current global shock as a combination of increased demand for goods and a supply side that was not flexible enough to meet the demand. Added to this are developments in energy markets in some countries that added to upward pressure on inflation.

Lowe’s expectation is that inflation from these sources will moderate over the next 18 months as demand rebalances towards services and supply of goods adjusts. But much will depend on how the labor market responds as demand for services picks up.

Additionally, Lowe reiterated that Australia has little historical experience as to how the labor market works at an unemployment rate of 4%, and there is also the uncertainty of how the effect of the reopening of the international border on labor supply.

“It is therefore possible that faster-than-expected progress continues to be made towards achieving the inflation target. If so, there would be a case to lift the cash rate before 2024,” Lowe said.

While a slower-than-expected progress to inflation goal was also possible, Lowe repeated that RBA’s latest data and forecasts do not warrant an increase in the cash rate in 2022.

“The economy and inflation would have to turn out very differently from our central scenario for the board to consider an increase in interest rates next year,” Lowe said.

“It is likely to take time to meet the condition we have set for an increase in the cash rate and the board is prepared to be patient,” he added.

In the speech, Lowe said most central banks and international organisations have concluded that the increase in inflation is likely to be temporary, and this is vindicated by market pricing.

He pointed out that market pricing indicates a modest increase in policy interest rates is anticipated, with rates expected to plateau at what would be still historically low levels.

“This is consistent with the view that the current increase in inflation is only transitory and that a period of contractionary monetary policy will not be required to return inflation to target,” Lowe said.

On monetary policy, Lowe said it is hard to precisely define what “sustainably in the target range” means.

While it means the RBA wants to underlying inflation well within the 2% to 3% range and have a reasonable degree of confidence that it will not fall back again, the trajectory for inflation is also important, with a slow drift up in underlying inflation having different policy implications to a sharp rise.

Another important consideration will be developments in the labour market and unless labour productivity growth is very weak, a wage growth of 3% would be required.

Lowe, however, clarified that RBA doesn’t have a target for wages growth or it is the only determinant of inflation.

“Rather, we are using wages growth as one of the guideposts in assessing progress towards our goal and whether inflation is sustainably in the target range,” he said, adding, the RBA will provide further guidance as the economy gets closer to its goal.

 As we get closer to that goal, you could expect us to provide further guidance, including our projections for inflation.

This is consistent with the view that the current increase in inflation is only transitory and that a period of contractionary monetary policy will not be required to return inflation to target.

--Contact: Sophia@centralbankintel.com