Too early to declare victory over inflation, says RBA’s Lowe

The Reserve Bank of Australia’s outgoing governor, Philip Lowe, said it has made progress in taming inflation but may have to tighten monetary policy further.

“We have made progress here and things are moving in the right direction, but it is too early to declare victory,” Lowe said at his last appearance in parliament as governor.

Lowe will be presiding over his last monetary policy meeting on September 5. He has been the RBA governor since September 2016. His successor, current deputy governor Michele Bullock, will begin her seven-year term on September 18.

In June, consumer price index (CPI) inflation was 5.4% year-on-year, down marginally from 5.5% in May, but still above the RBA’s target of 2–3%. Quarterly inflation increased by 6% year on year in the second quarter, slowing from a peak of 7.8% in the fourth quarter of 2022.

Lowe said the RBA expects inflation to decline further over the quarters ahead. The central bank expects CPI inflation to be around 3.25% by the end of next year, and return to target by late 2025.

Since May 2022, the RBA’s board has raised its policy rate by a total of 400 basis points to 4.1%. It paused its tightening cycle in April, after raising interest rates for 10 consecutive meetings, but delivered two more rate hikes in May and June.

Policy-makers held the policy rate unchanged at the two previous meetings in July and in early August, saying they needed time to assess the impact of past increases and the economic outlook.

“It is possible that some further tightening of monetary policy will be required to ensure that inflation returns to target within a reasonable timeframe,” Lowe said. The board will continue to assess the economic outlook in deciding whether to further tighten policy.

The governor said the board is mindful it has raised interest rates by a large amount over a short period and that there are policy lags. Monetary policy is now in “restrictive territory” and is working to establish a better balance between supply and demand.

The Australian economy is going through a period of below-trend growth, which is likely to continue for a while, Lowe said. The RBA expects economic growth to remain subdued for the rest of the year, before gradually picking up to around 2.25% by the end of 2025.

“Narrow path”

The governor said recent data is consistent with a “narrow path” that would see inflation falling over a reasonable timeframe while unemployment remains low.

Lowe noted Australia’s unemployment rate has stayed around 3.5%, though recent data suggest there has been some easing in the labour market. The RBA expects the unemployment rate to rise gradually to around 4.5% late next year.

However, there are risks that call for attention. “Many households are facing a painful squeeze on their budgets and consumer demand has slowed considerably, not least because high inflation is eroding people’s real incomes,” Lowe warned.

Around one million borrowers have already transitioned from low fixed-rate loans to loans with higher interest rates, the governor said. Around another one million  borrowers will make that transition over the next 18 months.

Sticky services inflation

Services inflation is still rising strongly and might prolong the period of above-target inflation, Lowe said. This was driven by a hangover in demand as well as weak productivity growth.

The RBA’s forecasts assume productivity would pick up to near pre-pandemic levels, which would help moderate growth in unit labour costs and inflation. “If this pick-up in productivity does not occur, all else constant, high inflation is likely to persist, which would be problematic,” he said.

Persistent high inflation could lead to higher inflation expectations, prompting businesses and workers to adjust their behaviour and making monetary policy more difficult. The board is trying to strike the right balance between reducing inflation in a timely manner and preserving as much employment as possible, he said.