RBA Governor: “remarkable resilience”

Testimony by Reserve Bank Governor

What happened? The Reserve Bank Governor Philip Lowe addressed the House of Representatives Standing Committee on Economics.

Implications: The Reserve Bank believes the economy will rebound quickly once restrictions are eased. But it will take time for inflation and wages to lift to desired annual growth rates. Wage growth should remain below three per cent over the next few years. So official interest rates are expected to stay low until 2024. Bank margins and revenues tend to rise more in a rising rate environment. Bank shares today were up 0.2 per cent in as flat market.


What did he say and what does it mean?

• Governor Lowe made five key points:

• The Australian economy has bounced back quicker and stronger than was earlier expected.

• The recovery has been interrupted by outbreaks of the highly infectious Delta strain of the coronavirus, especially in New South Wales.

• The economy is expected to bounce back quickly once the restrictions ease.

• We have not seen the same upside surprises in wages and prices that we have experienced in jobs and output, and that it will take some time for inflation to be sustainably in the 2 to 3 per cent target range.

• The RBA’s package of monetary policy measures is providing substantial support to the Australian economy in the face of lockdowns and the expected resumption of the economic expansion.

What do you need to know?

Forecasts: “Our central scenario is that the economy will return to strong growth in 2022, with GDP increasing by a little over 4 per cent, to be followed by growth of around 2½ per cent in 2023. In this scenario, the unemployment rate resumes its downward path to reach around 4¼ per cent by the end of next year and 4 per cent the following year.”

• Wage and price forecasts: “…both wages growth and underlying inflation pick up, but do so only gradually. The central forecast is for underlying inflation to be 1¾ per cent over 2022 and then 2¼ per cent over 2023. Growth in the Wage Price Index is expected to pick up gradually to 2¾ per cent over 2023, with growth in other measures of labour costs slightly higher than this.”

• Inflation target: “…the Board will not be increasing the cash rate until inflation is sustainably in the 2 to 3 per cent range. We want to see results on inflation before we move, not a forecast of inflation in the target range. It will not be enough for inflation to just sneak across the 2 per cent line for a quarter or 2. We want to see inflation well within the target band and be confident that it will stay there.”

• On bond purchases: “At the board’s meeting earlier this week we considered the case for delaying this tapering to A$4 billion a week.” The critical issue here is the outlook for the economy. As I discussed earlier, we are expecting a return to strong growth next year. Any additional bond purchases would have their maximum effect at that time and only a very small effect right now when the extra support is needed most. The Board also recognised that fiscal policy is the more appropriate instrument for providing support in response to a temporary and localised hit to income, and the Board welcomes the substantial fiscal response by governments in Australia. We will, however, keep the situation under review and are prepared to act in response to further bad news on the health front that affects the outlook for the economy over the year ahead.”

• On the 3-year bond target: “The decision not to extend the target to the next maturity reflects a shift in the probabilities regarding future movements in the cash rate. When the 3-year yield target was introduced last year, it was difficult to conceive scenarios in which the cash rate would be increased over the subsequent 3 years, which at the time ran to early 2023. Eighteen months on, there are now plausible scenarios in which the cash rate is increased over a 3-year horizon, which now runs until late 2024. Given this shift, the Board decided that it was not appropriate to extend the yield target to the end of 2024.”

Questions & answers

• The Governor remarked on the “remarkable resilience” of Aussie consumers and businesses.

• The Governor believes the probability is low that the economy will experience two consecutive quarters of negative GDP. In a worst case scenario the Reserve Bank could increase bond buying or it could buy other public sector assets.

• The Governor highlighted the importance of Australians getting vaccinated.

• Even in two years’ time annual aggregate wage growth will be below 3 per cent.

• Border restrictions are having a very significant effect on population growth, economic growth and employment growth. The Governor made no estimate on future levels of migration. But it is highly desirable that businesses can have access to skilled workers they need.

• Inflation concerns – most discussion has come out of the US. Investors were concerned that stimulus could lead to higher inflation. US inflation concerns have dissipated more recently.

• The Governor is not especially worried about inflation in Australia. The expectation that wages will below 3 per cent for the next few years will keep inflation contained. Wage growth of ‘2 point something’ means we are not going to have a problem with inflation.

• There was a question posed about the payments system including the impact of devices like Apple Pay.

• Question posed claiming bond purchase decision made on Tuesday amounted to a tightening of monetary policy. The Governor rejected that assertion.

• Question on negative interest rates. The Governor made the observation that no central bank that had interest rates in positive territory went into negative territory.

• Question about media calls for a review of monetary policy conducted in Australia.

• Question asked whether further details should be published on Reserve Bank Board.

• Question asked on composition of Reserve Bank Board.

• Question on wage growth. Governor notes that the supply curve is flatter when there is access to overseas job markets.

• Question to Assistant Governor (Economic) Luci Ellis on Doherty Institute report on modelling of delta variant cases and vaccination rates. RBA has assumed some limited lockdowns into the December quarter.

• Question on the Australian dollar. One reason that the RBA bought bonds is that other central banks were doing it and if you didn’t then the Aussie dollar would go up. The Governor noted that he didn’t want to the dollar to rise.

Published by Craig James, Chief Economist, CommSec