Powered by MOMENTUM MEDIA
investor daily logo

Lowe flags ‘inflation mentality’ risks, denies ‘scare campaign’

  •  
By Charbel Kadib
  •  
5 minute read

Complacency in the battle against inflation could “entrench” cost-of-living pressures, the Reserve Bank governor has warned, countering the federal government’s concerns over overheated rhetoric.

Prime Minister Anthony Albanese recently accused the federal opposition of engaging in a “concerted scare campaign”, claiming Liberal leader Peter Dutton was “catastrophising” the state of the economy amid the ongoing battle against inflation.

But in his appearance before the Senate standing committee on economics on Wednesday (31 May), Reserve Bank governor Philip Lowe stressed the importance of communicating inflation risks to ensure households and businesses do not develop an “inflation mentality”.

“We’re not engaged in a scare campaign, but what we’re trying to do is to remind people of our seriousness of getting inflation back down,” he said.

==
==

The Reserve Bank governor warned complacency could exacerbate cost pressures if businesses adjust their wage and price settings in anticipation of prolonged inflationary pressures.

“If we’ve got an inflation mentality, firms are more likely to put their prices up, they’re more likely to agree to big wage increases and workers are more likely to see it,” governor Lowe told the Senate.

“If that happens, then inflation becomes entrenched. We know from history if inflation becomes entrenched, it’s very costly.

“It will lead to higher interest rates and more unemployment.”

He acknowledged while higher interest rates are “hurting people”, the RBA is wary of the alternative.

“If we had not increased interest rates broadly as we have, inflation will be higher for longer, expectations would adjust and will become entrenched,” he added.

“The end result would be even higher interest rates, more pain, and more unemployment.

“…So, it’s not a scare campaign, but we do want people to understand that we’re serious about this and why we’re serious about it.”

The RBA has lifted the cash rate by a cumulative 375 bps since commencing a monetary policy tightening cycle in May 2022.

The board is scheduled to meet next Tuesday (6 June) to determine the RBA’s next move, with economists split on whether the central bank has done enough to sustain disinflation.

But governor Lowe said the central bank remains open to further tightening if needed to return inflation to the 2–3 per cent target range by mid-2025.

“We will do what’s necessary to make sure that inflation does not stay too high for too long, and we’re hoping we can tread this narrow path that I’ve been talking about — the economy still grows, unemployment rises a bit, but not too much,” he said.

“But if it’s not possible to do that, we will do what’s necessary to make sure inflation comes back within the target range in the next few years.”

Governor Lowe’s remarks came just hours before the Australian Bureau of Statistics released its latest monthly consumer price index (CPI).

The data revealed annualised inflation picked up in April, rising to 6.8 per cent — the first monthly increase in the 2023 calendar year and above market expectations of 6.4 per cent.

Fiscal policy pressures ‘neutral’

During his appearance, governor Lowe also echoed remarks by Treasury secretary Steven Kennedy during his evidence on Tuesday (30 May).

Governor Lowe said the Albanese government’s 2023–24 budget, which included approximately $20 billion in new spending over the next three years ($3–4 billion in 2023), would not add to inflationary pressures.

“We’ve got to keep this in perspective, though, that the Australian economy is over $2 trillion in a given year. That’s a lot,” he said.

“The extra spending from the government this year is three or $4 billion in a $2 trillion economy. That doesn’t shift the needle in terms of macroeconomic outcomes.

When pressed to assess whether the budget was contractionary or expansionary, the governor described current fiscal policy as “broadly neutral”.

“Labels are kind of dangerous, but I’d say it’s broadly neutral and monetary policy is contractionary,” he said.

The RBA is projecting GDP growth of 1.25 per cent in 2023 and 1.75 per cent in 2024.

Over the same period, CPI inflation is tipped to slow to 4.5 per cent by the close of the 2023 calendar year, before easing further throughout 2024 and returning to target by June 2025.

Progress towards the inflation target is expected to have a minimal impact on labour market conditions, with rapid disinflation to result in just an 80 bps increase to the unemployment rate — rising to 4.5 per cent by June 2025 (currently 3.7 per cent).