By Shane Wright
Not only does the Reserve Bank have to worry about real inflation – now it’s concerned Australian consumers and businesses could talk themselves into cost-of-living problems.
Central banks like the RBA have their own term for the way people can convince themselves that inflation is rampant. It’s called inflation psychology, and Reserve Bank governor Philip Lowe is convinced it could be brewing here in Australia.
RBA governor Philip Lowe had not used the term “inflation psychology” since taking over the bank in 2016. That all changed in two speeches last week.Credit: Brent Lewin
Dr Lowe has been governor of the RBA – whose main job is to hold inflation between 2 and 3 per cent – since 2016.
Over that period he has given numerous speeches and prepared remarks about the economy, the jobs market, the future of money and even about the link between trust and prosperity.
In all those speeches, Dr Lowe never mentioned the term “inflation psychology”. But that changed last week.
In two addresses he used the term on five separate occasions. Comments by the governor are parsed to the comma, so such a change was akin to the day footballers switched from drop kicks to drop punts.
Speaking to the AFR Business Summit, Dr Lowe said that after two decades worth of “low-inflation psychology”, central banks were now having to deal with a lift in prices well above their cumulative comfort zones.
Two days later, he went further, telling a banking conference that one issue the RBA was paying close attention to was “inflation psychology”.
He warned higher inflation could lead to a “psychology shift” as people came to expect price rises while businesses responded by lifting wages that in turn fed into a spike in inflation.
“We’re watching very carefully for any shift in inflation psychology. If that shift were to occur, inflation would be higher and more persistent and we would need to respond to that over time,” he said.
In other words, if consumers and businesses start believing inflation is here to stay, and respond by pushing up prices, the Reserve Bank has to lift interest rates. And the bank may have to take those rates higher – and hold them there longer – than if inflation expectations were more moderate.
Shoppers are already feeling a lift in prices across the nation’s supermarkets.Credit: Michele Mossop
CommSec chief equities economist Craig James said the concern is that our expectations about inflation could become detached from reality, which then means changes to how we spend or how a business operator sets their prices.
“If people feel like prices are going to go up 3 or 4 or 5 per cent rather than 1 or 2 per cent, then that’s a problem. It means you end up expecting prices to go up more, then they do, then you can end up with inflation being entrenched,” he says.
On Tuesday, ANZ’s weekly measure of consumer sentiment showed household expectations rose to 5.6 per cent, its highest level since November 2012.
Westpac’s most recent measure of consumer sentiment showed the proportion of people recalling news about inflation reached 38.7 per cent in March. A year ago, it was just 8.6 per cent.
Countless studies show consumers (and businesses) are bad judges when it comes to inflation. While consumers back in November 2012 thought inflation was on its way to 5.6 per cent, the actual rate was only 2.2 per cent.
But soaring prices for everything from petrol and houses to biscuits and cans of baked beans are very real and very obvious to consumers and businesses.
Central banks like inflation expectations to be anchored. It’s one of the core reasons why the RBA has had a target of inflation between 2 and 3 per cent for past three decades.
But the fear growing within the bank is that the inflation ship has slipped its anchor.
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