RBA warns underlying inflation will jump as high as 3.25pc, ends QE and holds rates

Philip Lowe warns underlying inflation will jump as high as 3.25 per cent in 2022, but has pushed back against talk of rate hikes this year.

Reserve Bank Governor Philip Lowe says ‘the Omicron outbreak has affected the economy, but it has not derailed the economic recovery’. Picture: James Brickwood

Reserve Bank governor Philip Lowe has offered no sign he is preparing to hike rates this year, ­despite predicting underlying ­inflation will climb as high as 3.25 per cent, as he declared an end to the central bank’s $350bn bond-buying program.

In a statement accompanying the decision to hold the cash rate target at 0.1 per cent, Dr Lowe ­delivered an upbeat assessment of the economy, predicting unemployment later this year would drop below 4 per cent for the first time in nearly five decades, and fall as low as 3.75 per cent in 2023.

“The Omicron outbreak has affected the economy, but it has not derailed the economic recovery,” he said. “The Australian economy remains resilient and spending is expected to pick up as case numbers trend lower. Hours worked are estimated to have ­declined significantly in January due to the Omicron outbreak, but high numbers of job vacancies suggest further gains in employment over the months ahead.”

With petrol prices surging and the prices of essential goods such as childcare, groceries and education rising by 4.5 per cent in 2021, cost-of-living pressures loom as a potentially contentious issue at this year’s election.

Scott Morrison in his National Press Club address in Canberra on Tuesday said “the inflationary pressures on Australia are building, but they are not like we are seeing overseas” – a view echoed by Dr Lowe.

The Prime Minister said his government’s “focus is squarely on locking in our economic recovery to create jobs, jobs and more jobs”.

Dr Lowe said core inflation – the central bank’s preferred measure, excluding more volatile price changes – was now expected to climb from 2.6 per cent in December to 3.25 per cent “in coming quarters”, taking it well above the RBA’s 2-3 per cent target and to its highest level since mid-2009.

After reaching 3.25 per cent, consumer price growth would then settle to 2.75 per cent in 2023, as Covid-related disruptions were resolved, Dr Lowe said. Despite the massively upgraded inflation forecasts – the central bank in ­November forecast core inflation would only be 2.25 per cent by the end of 2022 – Dr Lowe reiterated that the RBA board was “prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve”.

“While inflation has picked up, it is too early to conclude that it is sustainably within the target band. There are uncertainties about how persistent the pick-up in ­inflation will be as supply-side problems are resolved,” he said.

Despite Dr Lowe’s pledge to remain “patient”, economists reiterated their calls for a first rate hike between August and November.

NAB global head of research Ivan Colhoun said the RBA’s ­inflation outlook “suggest the central case for the first interest rate increase has shifted considerably earlier from the previous 2024 rate rise guidance”.

“The forecasts seem consistent with a move later in 2022, which is now much more possible than the ‘very unlikely’ characterisation the governor made in late 2021,” Mr Colhoun said. “Wages growth also remains modest and it is likely to be some time yet before aggregate wages growth is at a rate consistent with inflation being sustainably at target.”

The RBA’s preferred wage price index climbed by only 2.2 per cent over the year to September, and Dr Lowe has indicated wages growth of above 3 per cent will be needed to meet his inflation goals.

“A further pick-up in wages growth is expected as the labour market tightens. This pick-up is still expected to be only gradual, although there is uncertainty about the behaviour of wages at historically low levels of unemployment,” he said.

Dr Lowe said the decision – widely expected by analysts – to end quantitative easing was in line with the actions of other central banks, and that “more importantly, faster-than-expected progress has been made towards the RBA’s goals and further progress is likely”.

“In these circumstances, the board judged that now was the right time to end the bond purchase program,” he said, noting the final purchases would take place on February 10.

But Dr Lowe took the opportunity to hose down forecasts that a monetary policy tightening was on the cards. “Ceasing purchases under the bond purchase program does not imply a near-term ­increase in interest rates,” he said.

“The board is committed to maintaining highly supportive monetary conditions to achieve its objectives of a return to full employment in Australia and inflation consistent with the target.”

Dr Lowe will address the ­National Press Club on Wednesday, and the central bank will ­release its full updated set of economic forecasts in Friday’s quarterly Statement on Monetary Policy. Data released last week showed underlying inflation jumped to 2.6 per cent over the year to December, above the midpoint of the central bank’s 2-3 per cent target range for the first time since 2014, and two years earlier than expected by the RBA’s economists.