Speaking at the Reserve Bank (RBA) board dinner, governor Philip Lowe said that while he understands that the higher interest rates are unwelcomed by many people, the consequences of allowing high inflation to become entrenched in expectations include a severe recession and a sharp rise in unemployment.
“At our meeting, we discussed how the higher interest rates are putting pressure on family budgets, just at the time that high petrol prices and grocery bills are also squeezing budgets. We are conscious of this and are certainly taking it into account,” Dr Lowe said.
“We also discussed the consequences of not raising interest rates, and allowing high inflation to persist and become entrenched in expectations. If this were to happen, the evil of inflation would be with us for longer and the eventual increase in interest rates needed to bring it down would be greater.
“This would increase the risk of a severe recession and a sharp rise in unemployment. It would be much better to avoid such a costly outcome and so we have acted strongly to avoid it”.
The board, he reiterated, is seeking to return inflation to the 2 to 3 per cent range while at the same time keeping the economy on an even keel.
“It is still possible to do this, but there is a lot of uncertainty and we could be knocked off that narrow path, not least because of developments elsewhere in the world,” Dr Lowe explained.
He also addressed the board’s pivot to more standard quarter percentage point increases in October, noting that the large half percentage point increments were required to move interest rates quickly away from their pandemic levels and address the rapidly emerging inflation problem.
“As interest rates moved back to more normal levels, the board judged that it is appropriate to move at a slower pace while we assessed the data, the economic outlook and the impact of the rate rises to date,” Dr Lowe said.
“We are conscious that interest rates have been increased by a large amount in a very short period of time and that higher interest rates affect the economy with a lag. If we are to stay on that narrow path, we need to strike the right balance between doing too much and too little”.
The board’s base case, he said, remains that interest rates will need to go higher still to bring inflation back to target.
“Given the uncertainties regarding the outlook, we will be watching very carefully how the economy and the inflation pressures evolve over the summer,” Dr Lowe said.
The governor also looked back at his time in Washington DC at the G20 and IMF meetings and painted a picture of a dire global backdrop.
“It was a sobering experience,” Dr Lowe said.
“We heard that inflation globally is way too high; the rising cost of living is hurting many households; the world is falling behind on the agreed carbon reduction targets; war is once again tragically occurring in Europe; and the global economy is becoming more fragmented. As you can imagine, there was not much cheer around, even for somebody like myself who sees the glass as half-full”.
“One challenge that is facing all Australians is high inflation,” the governor added. As such, he said, the RBA now expects inflation to increase further to reach around 8 per cent later this year.
On Tuesday, the RBA lifted interest rates to 2.85 per cent in its first November rate rise since 2010.
