Philip Lowe: Opening statement to the House of Representatives
Standing Committee on Economics
Opening statement by Mr Philip Lowe, Governor of the Reserve Bank of Australia, to the House
of Representatives Standing Committee on Economics, Sydney, 11 February 2022.
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Chair
Members of the Committee
Good morning. My colleagues and I look forward to the day where we can return to in-person
hearings. We hope that will be for the next hearing.
I would like to focus my introductory remarks today on three issues: the economic recovery; the
outlook for inflation; and the RBA's monetary policy decisions.
The economic recovery
At the time of the previous hearing in August, we were in the early days of the Delta lockdowns
and were expecting a strong bounce-back when the restrictions were eased. This bounce-back
did eventuate and the economy had strong momentum late last year. Then Omicron hit, which
has been a significant setback for many people and businesses. Yet, once again, the economy
has proven to be resilient. Despite the disruption caused by Omicron in January, we still expect
positive growth in GDP in the March quarter, with spending and hours worked already recovering.
Reflecting this resilience, the outlook for the Australian economy has improved since we last
met. We estimate that GDP increased by around 5 per cent over 2021 and are expecting GDP
growth of around 41⁄4 per cent over 2022 and 2 per cent over 2023.
This outlook is being underpinned by a number of factors. These include household balance
sheets that are in generally good shape, with households having accumulated more than
$200 billion in additional savings over the past two years. An upswing in business investment is
also under way and there is a large pipeline of residential building to be completed over the next
year or so. Macroeconomic policy settings are supportive of growth, with governments planning
significant infrastructure spending and monetary policy remaining very accommodative.
The resilience of the economy is evident in the Australian labour market, where the outlook has
continued to improve. A year ago, our central forecast was that the unemployment rate would be
close to 6 per cent at the end of 2021. The outcome was much better than this: 4.2 per cent.
There has also been a welcome decline in underemployment as many people have been able to
obtain additional hours. Labour force participation has increased and the share of the working
age population with a job has never been higher than it is now.
The forward-looking indicators suggest further growth in jobs over the months ahead with
vacancies at a very high level. Our central forecast is for the unemployment rate to decline to
below 4 per cent later this year and remain below 4 per cent next year. If this comes to pass, it
would be a significant milestone. Australia has not experienced unemployment rates this low
since the early 1970s, almost half a century ago.
The main source of uncertainty about the outlook continues to be COVID-19. The pandemic is
not yet behind us and it is entirely possible that there will be more outbreaks. It also remains to be
seen how households use all those savings that they have accumulated over the past two years.
There are major geopolitical uncertainties and our largest trading partner, China, is working
through a difficult adjustment in its property market. The sharp pick-up in inflation in parts of the
world, especially in the United States, has come as a surprise and is an additional source of
uncertainty about the outlook.
Inflation
For the first time in several decades, inflation has become a major issue in the global economy,
although it is worth noting that inflation rates in most of Asia remain low. In the United States, CPI
inflation is running at more than 7 per cent and in the United Kingdom it is expected to be at a
similar rate soon. In Germany, inflation is 5.7 per cent and in New Zealand it is 5.9 per cent.
These are the highest rates in decades and the higher inflation is turning out to be more
persistent than earlier expected.
This lift in inflation largely reflects the surge in global demand for goods during the pandemic
coinciding with a reduced ability of the global economic system to produce and distribute goods.
A related factor in a few countries, including the US and the UK, has been a decline in labour
force participation, which has reduced the supply of labour and contributed to stronger wages
growth. Higher prices for petrol, electricity and gas have also pushed inflation up in many
countries.
In Australia, we too have had higher inflation than we and others expected, although the increase
here is smaller than in many other countries. In headline terms, inflation is 31⁄2 per cent and in
underlying terms it is 2.6 per cent. We are feeling the effects of global supply-chain problems and
higher oil prices, but we have not seen the same increases in goods prices as have occurred in
the United States. It is also relevant that the prices that Australian households pay for utilities are
little changed and have not gone up sharply like the prices of utilities in Europe. Rent inflation has
also been lower in Australia than elsewhere.
Looking ahead, we expect a further lift in underlying inflation. There is also likely to be a shift in
the drivers of inflation. Our central forecast is that underlying inflation will increase to 31⁄4 per cent
in the coming quarters, before easing to around 23⁄4 per cent. This increase in the short term
primarily reflects the ongoing effects of supply-side disruptions, most recently due to Omicron, at
a time of strong demand. As these supply-side pressures are resolved, some of the current
upward pressure on prices is expected to abate. An offset to this, though, is expected to be
stronger growth in labour costs due to the tighter labour market.
Wages growth has picked up recently, but only to the low rate prevailing before the pandemic.
The vast bulk of Australians are still experiencing wages increase of no more than 2 point
something per cent, although there are areas where the increases are much larger than this and
non-wage benefits are also increasing. A further pick-up in overall wages growth is expected,
although this is likely to be a gradual process given the institutional features of our labour market
- including multi-year enterprise agreements, an annual review of award wages and
publicsector wages policies. We are also expecting broader measures of labour costs to pick up faster
than the Wage Price Index.
There is, however, more than the usual degree of uncertainty around the outlook for inflation and
wages. It is still unclear as to whether, and at what pace, the demand for goods will normalise as
infection rates decline. The speed at which the supply side of the economy can respond to
changes in the demand side is also uncertain. And we have no contemporary experience to
assess how wage outcomes will evolve at a national unemployment rate below 4 per cent.
A broader uncertainty is the extent to which other central banks will have to increase interest
rates to return inflation to lower rates. Central banks and financial markets expect that a decline
in inflation to target can be achieved without real policy interest rates returning to positive territory.
It is entirely possible, though, that countries with higher inflation rates will need a bigger
adjustment in interest rates than currently anticipated. If so, this could result in an abrupt
adjustment in financial conditions.
Monetary policy
I would now like to turn to Australian monetary policy, where there have been a number of
significant developments since we last met, including the discontinuation of the yield target, the
cessation of the bond purchase program and a change in the outlook for interest rates.
The yield target for the April 2024 bond was discontinued in early November. Up until that point
the target had played an important role in anchoring the yield curve and keeping funding and
borrowing costs low in Australia. In early October, the yield on the target bond was sitting at close
to zero per cent. But then, a flow of stronger-than-expected data, both here and abroad, resulted
in a shift in the distribution of possible future outcomes for the cash rate. In particular, these data
implied that there was a reasonable probability of an increase in the cash rate before 2024. This
assessment was reached by both the RBA and financial market participants and it was reflected
in market prices. In these circumstances, the Board judged that there were more costs than
benefits in seeking to continue to anchor the yield on the April 2024 bond at 10 basis points. The
removal of the target was associated with volatility in the bond market. The RBA is conducting a
review of the whole experience with the yield target and the results will be published later this
year.
In terms of the bond purchase program, the final purchases were made yesterday. All up, across
the various programs, the RBA has purchased $350 billion of bonds issued by the Australian
Government and by the states and territories. These purchases have lowered funding costs,
supported asset prices and led to a lower exchange rate than otherwise. As a result, more
people have jobs and inflation is closer to target. The stock of bonds purchased will also continue
to support accommodative financial conditions in Australia.
The decision to end the bond purchase program followed a review of the three considerations we
have used from the outset: (i) the actions of other central banks; (ii) the functioning of our bond
market; and (iii) the actual and expected progress towards our goals. All three considerations
pointed to the same conclusion - to end the program. Of these three considerations, the most
important was that faster-than-expected progress has been made towards our goals of full
employment and inflation consistent with the target.
The final development has been the change in expectations about the future path of interest
rates. Since the onset of the pandemic, the Board has said that it will not increase the cash rate
until inflation is sustainably in the 2 to 3 per cent range. When we last met, this condition was not
expected to be met before 2024 in the RBA's central scenario. Since then, the economy has
performed better and inflation has been higher than in that scenario. As a result, interest rate
expectations have moved higher.
It is too early, though, to conclude that inflation is sustainably in the target range. In underlying
terms, inflation has just reached the midpoint of the target band for the first time in over seven
years. And this comes on the back of very large disruptions to supply chains and distribution
networks, which are expected to be only temporary. It also comes at a time when aggregate
wages growth is no higher than before the pandemic, which was associated with inflation being
persistently below target.
In these circumstances, the Board is prepared to be patient. We have scope to wait and see how
the data develop and how some of the uncertainties are resolved. Countries with higher inflation
rates have less scope here.
I recognise that there is a risk to waiting but there is also a risk to moving too early. Over the
period ahead we have the opportunity to secure a lower rate of unemployment than was thought
possible just a short while ago. Moving too early could put this at risk. At the same time, we are
committed to maintaining low and stable inflation and will do what is necessary to achieve this
important goal. The stronger the economy and the more upward pressure on prices and wages,
the stronger will be the case for an increase in interest rates.
I would like to end with a brief reflection about the past couple of years.
Throughout the pandemic, the RBA has had to make decisions in a highly uncertain environment
in which there have been many moving parts. Over the two years, we have sought to provide the
support the Australian economy needed and to play our role in building the bridge to the other
side. Our actions have also been motivated by providing the country with insurance against the
possibility of large downside risks that could have damaged the economy and hurt the welfare of
the Australian people. Throughout this period, some things have worked out as expected but
there have been plenty of surprises along the way. The RBA is committed to fully examining this
experience in an open and transparent manner and to drawing lessons for the future.
I will close on that note.
In the interests of time, I will not make any introductory remarks regarding the many payments
system issues that the RBA is working on, but we would welcome the opportunity to talk about
these during the hearing, if that were possible.
Thank you. My colleagues and I are here to answer your questions.