RBA Governor: wages growth key to inflation spike

Reserve Bank Governor speech; Purchasing managers’ indexes

The Reserve Bank Governor Philip Lowe participated in an online panel at Universidad de Chile’s Conference on Central Bank Independence, Mandates and Policies this morning. Governor Lowe said he did not think the rise in inflation would be sustained unless it led to sustainably higher wages growth.

The preliminary Australian IHS Markit Composite Purchasing Managers’ index (PMI) rose from 46 in September to a 4-month high of 52.2 in October. A reading above 50 indicates an expansion in activity.

Reserve Bank Governor Philip Lowe at Universidad de Chile’s Conference

• Reserve Bank (RBA) Governor Philip Lowe participated in an online panel this morning at Universidad de Chile’s Conference on “Central Bank Independence, Mandates and Policies.”

• Governor Lowe’s remarks didn’t address the outlook for monetary policy or the Australian economy, instead focusing on its key policy frameworks and mandates.

• Dr. Lowe re-stated the RBA’s three objectives for determining monetary policy:

• The stability of the Australian dollar, including low and stable inflation;

• Full employment;

• The economic welfare and prosperity of the Australian people.

• Governor Lowe also made the following key points:

“Adding an exchange rate objective to the central bank’s other objectives would severely compromise the achievement of those other objectives and produce, on average, poorer results.”

• On inflation: “We have found a flexible medium-term inflation target works well.”

• On wages: “Is it going to reset expectations about what type of wage growth people should get, or will the spike dissipate and we will go back to the type of labour market outcomes we’ve seen before the pandemic? So there is quite a lot of uncertainty around that issue, but we are watching very carefully.”

• “In terms of full employment, we do not have a numerical target and I don’t think it makes sense to do so.”

• “At its core, the relationship between the government and the central bank in Australia is one based on constructive dialog.”

• “The government also supports a high level of transparency by the RBA, including through publications and speeches and public appearances before parliamentary oversight committees.”

• “There is no right answer to the questions that Chile is grappling with. But Australia’s experience is that the combination of a freely floating exchange rate, a flexible medium-term inflation target and a broad mandate for the central bank can work well for a small open economy.”

• Australia’s broad mandate provides “an extra degree of freedom” in responding to economic shocks. “This is especially so in the case of supply shocks, where output and inflation move in different directions.”

• While today’s speech will have little bearing on financial markets, US government bond yields continued their upward march overnight as investors continue to anticipate faster inflation as the US labour market tightens, potentially stoking wage gains. While the US Federal Reserve is expected to begin tapering its monthly asset purchases next month, bond traders have already begun pricing in two official interest rate hikes next year.

• Annual wage and underlying inflation growth remains relatively constrained in Australia, but the Commonwealth Government 3-year (April 2024) yield has jumped to 0.18 per cent in recent days, well above the RBA’s 0.1 per cent target, as traders bet that Governor Lowe will bring forward his rate hike plans from 2024.

Purchasing Managers’ indexes (PMIs) – October

• Australia’s post-Delta lockdown economic recovery is underway. Activity in Australia’s services sector expanded in October after three successive months of contraction due to government restrictions in Australia’s south-east. But surveyed business owners in both the services and factory sectors reported that price pressures were intensifying amid labour and raw material shortages, supply chain disruptions and port blockages.

• Of course, rising costs of inputs and production could eventually lead businesses to pass-on these higher costs to consumers through price hikes. As evidenced elsewhere in the world, rising consumer inflation expectations could potentially dampen confidence with households reluctant to spend in the near-term, delaying ‘big-ticket’ purchases.

• The preliminary Australian IHS Markit Manufacturing Purchasing Managers’ index (PMI) rose from 56.8 in September to 57.3 in October.

• The Services PMI lifted from 45.5 in September to 52 in October.

• The combined or composite PMI rose from 46 in September to 52.2 in October. All readings were at 4-month highs, with indexes above 50 indicating an expansion in activity.

• According to IHS Markit economists:

• “Following the turnaround in September, the IHS Markit Flash Australia Composite PMI indicated that the Australian economy is back in expansion in October as the easing of COVID-19 restrictions and plans for further opening up of the Australian economy restored confidence and rejuvenated economic activity in the country.

• The return to growth for demand and backlogged work likewise reflected the improvement in overall confidence, with business sentiment rising to the highest level since February.

• Higher demand however translated to greater strains on the supply chain as we saw vendor performance deteriorate and price pressures further accumulate in October. Meanwhile employment levels rose at a slower rate with reports of constraints when trying to hire staff. These are issues that may persist in the short- to medium term for firms as they take their time to clear.”

Published by Ryan Felsman, Senior Economist, CommSec