RBA governor Philip Lowe gets leeway over inflation targeting

The Reserve Bank has won greater flexibility in how it approaches the setting of interest rates from month to month.

RBA governor Philip Lowe.

The Reserve Bank has asked for and won greater flexibility in how it approaches the setting of interest rates from month to month, while also sharpening its watch on the stability of the nation’s banks.

After just hours in the top job, new RBA governor Philip Lowe yesterday outlined an agreement with Scott Morrison to preserve the bank’s 2-3 per cent inflation target as the cornerstone of decision making around interest rates.

But in recognition of a more complex global and domestic economic environment, the RBA can now interpret the inflation target a little more loosely, meaning inflation could stay outside the target band for longer if wider issues meant it was warranted.

With interest rates already at record lows, the RBA is tasked with lifting inflation over time against deflationary pressures from the global economy and stubbornly flat wages growth at home.

The RBA will need to move with some caution in cutting interest rates further as soaring property prices and record household debt could pose a risk to the nation’s banks if the surge is left unchecked.

“Both the Reserve Bank and the government agree that a flexible medium-term inflation target is the appropriate framework for achieving medium-term price stability,” the joint statement said.

“They agree that an appropriate goal is to keep consumer-price inflation between 2 per cent and 3 per cent, on average, over time,” it added.

This formulation allows for “the natural short-run variation in inflation over the economic cycle”, the statement said.

The medium-term focus gave the central bank flexibility to set policy to achieve its broad objectives, including financial stability, it added.

The 2-3 per cent inflation target has been central to RBA policy­making since the early 1990s. Many argue it has underpinned the 25 years of uninterrupted growth enjoyed by the nation.

With inflation now entrenched below that target, some commentators have argued it might be time to lower it or abandon it completely. Some have argued for it to be replaced by a GDP growth target.

The RBA has shown little interest in the calls for change, pointing the country’s economic performance over the past quarter of a century as evidence that it works. The policy agreement is renegotiated whenever a new treasurer or RBA governor is appointed. In this case, Dr Lowe ­yesterday formally took over from Glenn Steven as head of the RBA.

The Treasurer said the agreement would keep in place existing arrangements, but acknowledged financial sector issues more fully.

The agreement includes “a clearer expression of the framework as comprising a flexible ­medium-term target that will be pursued over time and by ­acknowledging that financial stability considerations can be relevant to monetary policy settings”, Mr Morrison said.

Australian banks are sound and well capitalised, but it is widely agreed that a major global shock from overseas could weaken the economy, push up unemployment and quickly rattle confidence in housing.

Financial stability has been an important part of the RBA’s policy considerations for some years, given fears linked to surging house price growth, which has in part been fanned by overseas ­demand.

“The new statement is simply seeking to make quite clear that below-target inflation does not warrant an automatic rate cut, and that the conduct of policy is ultimately nuanced,” said Adam Boyton, chief economist at ­Deutsche Bank.

Commonwealth Bank of Australia chief economist Michael Blythe said the changes to the agreement were “largely cosmetic”, and reinforce the RBA’s current practices.

Dr Lowe will appear before parliament on Thursday, when he is likely to comment on the new agreement more fully.

Dow Jones Newswires