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Bumpy ride ahead as RBA warns on wage rise

Workers who demand pay rises to compensate for higher inflation could create serious economic troubles, RBA governor Philip Lowe has declared.

RBA has raised cash rate for 12 of last 13 meetings as economists fear recession

Philip Lowe says it’s “still possible” to lower inflation to the Reserve Bank’s target within a reasonable time frame, but it’s a “likely to be bumpy, with risks on both sides”.

Speaking at the Morgan Stanley 5th Australia Summit on the topic of “The Narrow Path”, a defiant RBA governor said it's “our job at the central bank” is to ensure that the highest inflation levels in 30 years is “only temporary”, adding that “it’s important that we are successful here”.

“High inflation is corrosive and damages our economy,” he said.

“And if inflation stays high for too long, it will become ingrained in people’s expectations and high inflation will then be self-perpetuating.

“As the historical experience shows, the inevitable result of this would be even higher interest rates and, at some point, a larger increase in unemployment to get rid of the ingrained inflation.

“The board’s priority is to do what it can to avoid this.”

It comes after the RBA delivered raised interest rates by 25 basis points to a decade high of 4.1 per cent after Tuesday’s board meeting. In his post-meeting statement, Dr Lowe removed a line, repeated since July, that “inflation expectations remain well anchored”.

Philip Lowe said it’s “still possible” to lower inflation to the Reserve Bank’s target within a reasonable time frame. Picture: Flavio Brancaleone/NCA NewsWire
Philip Lowe said it’s “still possible” to lower inflation to the Reserve Bank’s target within a reasonable time frame. Picture: Flavio Brancaleone/NCA NewsWire

Dr Lowe has also warned that inflation will be difficult to manage if all workers receive a pay rise.

The comments made at the Morgan Stanley Australia Summit comes after the Fair Work Commission opted to deliver the biggest minimum wage hike on record.

“It is understandable that the lowest workers are compensated as it is tough for them at the moment,” he said.

“We will get ourselves into trouble if all workers feel the need to be compensated for high inflation.”

“If wages keep matching inflation then where do we think it will be next year … higher again and so forth.

“We’re in a difficult position when society understandably wants to protect the lowest paid workers, but we’ve got to make sure that the higher inflation doesn’t translate into higher wage outcomes for everybody.”

Dr Lowe said that it was a tricky balancing act, but the central bank wanted to avoiding measures that will stranspire into persistent inflation.

In his speech, Dr Lowe noted that returning inflation to the target requires “more sustainable balance between aggregate demand and supply” and “the tool that the RBA has to achieve this balance is interest rates”.

“I acknowledge that the use of this tool comes with complications,” he said.

“Its effects are felt unevenly across the community, with rising interest rises causing significant financial pressure for some households.

But this unevenness is not a reason to avoid using the tool that we have.”

Amid increasing political commentary on the impact of higher interest rates, Dr Lowe said it’s “certainly true that if the board had not lifted interest rates as it has done, some households would have avoided, for a short period, the financial pressures that come with higher mortgage rates”.

“But this short-term gain would have been at a much higher medium-term cost,” he said.

RBA governor Philip Lowe addresses the Morgan Stanley Australia Summit held at the Four Seasons Hotel in Sydney. Picture: Christian Gilles/NCA NewsWire
RBA governor Philip Lowe addresses the Morgan Stanley Australia Summit held at the Four Seasons Hotel in Sydney. Picture: Christian Gilles/NCA NewsWire

“If we had not tightened monetary policy, the cost of living would be higher for longer.

This would hurt all Australians and the functioning of our economy, and would ultimately require even higher interest rates to bring inflation back down.

“So, as difficult as it is, the rise in interest rates is necessary to bring inflation back to target in a reasonable time frame.”

Higher-than-expected April CPI data hasn’t changed the RBA’s assessment that inflation is trending lower, but “services price inflation in Australia remains high, rents are increasing quickly and there will be further large increases in electricity prices this year”, Dr Lowe said.

“In addition, unit labour costs are increasing briskly … these developments mean that it is too early to declare victory in the battle against inflation.”

While looking to “preserve as many of the gains in the labour market as possible”, Dr Lowe warned that this “does not mean that the Board will tolerate higher inflation persisting”.

“There is a limit to how long inflation can stay above the target band,” he said.

“The longer it stays there, the greater the risk that inflation expectations adjust and the harder, and more costly, it will be to get inflation back to target.”

“If inflation stays high, this will damage the economy and all Australians will feel the effects.”

Dr Lowe reiterated that Tuesday’s rate hike decision was taken to “provide greater confidence that inflation will return to target within a reasonable time frame” after “recent information that has suggested greater upside risks to the bank’s inflation outlook”.

“Services price inflation is proving persistent here and overseas, and the recent data on inflation, wages and housing prices were higher than had been factored into the forecasts,” he said.

“Given this shift in risks and the already fairly drawn-out return of inflation to target, the board judged that a further increase in interest rates was warranted.”

He said it was higher than the RBA had forecast, but its impact on inflation would depend on “whether it spreads across other parts of the labour market”.

“A concern would arise if the 5.75 per cent increase became a quasi benchmark for outcomes in private sector wages more broadly,” he said.

“I’m really hopeful that doesn’t happen, and the big increase last year didn’t become a benchmark for other increases … but the longer these big increases go on, the harder it will be for wage outcomes in negotiated agreements to stay where they are.

“So it’s a risk factor we’re monitoring, and the solution is stronger productivity growth to underpin big increases in nominal wages.”

Dr Lowe revealed that in making its decision, the board had a detailed discussion of the slowdown in household spending and the stresses on household finances from higher interest rates and rents.

“But it also considered the costs for households and the economy of inflation staying too high for too long. It is in Australia’s interest that we get on top of inflation and we do so before too long,” he said.

“The board will do what is necessary to achieve that.”

Dr Lowe noted that there were a “a number of factors that the board will be paying close attention to” as it makes its decisions “over the coming months”.

Overseas, he said core services inflation is proving “persistent” due to strong demand for many services and strong growth in wages, against a background of weak productivity growth.

“One source of ongoing uncertainty is how quickly services price inflation globally will moderate and whether the needed moderation will require further increases in interest rates,” Dr Lowe said.

“It is noteworthy that interest rates are higher in the other English-speaking advanced economies than in Australia, and are expected to go a little higher still.”

Consumption growth is expected to “remain subdued for some time”, albeit stronger population growth is expected to “provide some offset”.

A headwind for household spending from falling housing prices “looks to be coming to an end and could be replaced with a tailwind from increasing housing prices”

But real incomes have declined and required mortgage payments as a share of household disposable income will reach a record high later this year, while many households transition from low fixed-rate loans over the next few months and experience the increase in repayments that has been occurring for variable-rate borrowers.

Rents are also increasing quickly, putting pressure on some households’ finances, he said.

Dr Lowe also noted that growth in unit labour costs have been “increasing quite strongly” as “unfortunately, growth in productivity has been weak”.

And in regard to inflation expectations, he said the RBA’s longstanding survey of union officials showed their estimates of inflation over the next 5–10 years have “increased significantly after being very low for a number of years, and short-term expectations of households “are high at present.”

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Original URL: https://www.theaustralian.com.au/business/economics/inflation-fix-still-possible-rbas-philip-lowe/news-story/82eca22c7d9674a4686dcf8e8810bbce