Add Category
The new Reserve Bank governor Michele Bullock says interest rate rises are slowing the economy but continuing global shocks, such as the Israel-Gaza war, risk keeping inflation and interest rates higher for longer.
Key points:
- RBA governor Michele Bullock says inflation is coming down as per capita spending falls in response to higher interest rates
- But she warns that rising house prices, low unemployment and rising services costs are making inflation "sticky"
- She says continuing global geopolitical and supply shocks also risk embedding higher inflation for longer
Ms Bullock took over leadership at the RBA about a month ago. She said, like her predecessor Philip Lowe, she was facing a challenging set of economic circumstances.
Having raised the official cash rate from a pandemic low of 0.1 per cent to the current level of 4.1 per cent in less than a year and a half, the RBA boss said higher mortgage rates were already working to slow the economy.
"We think monetary policy is starting to bite," she said during a "fireside chat" at the Australian Financial Security Authority's (AFSA) inaugural annual summit in Sydney.
"We're seeing a slowdown in consumption. We're seeing, in fact, per capita consumption decline and what in fact is keeping aggregate consumption growing is population growth."
Moreover, that slowdown in spending is contributing to falls in inflation.
"As demand is starting to slow, businesses are finding it more difficult to pass on cost increases," she observed.
Housing 'surprise' and 'sticky' services raise inflation risks
However, Ms Bullock sounded a warning for anyone dismissing the possibility of further interest rate rises or counting on imminent rate cuts.
"There's a few things that are suggestive that it's going to be difficult to get inflation down," she cautioned.
Ms Bullock pointed to several domestic factors that were likely to keep price growth above the RBA's 2-3 per cent target for longer than it would like.
"Services inflation — inflation in things like takeaways, hairdressers, restaurants, those sorts of things — that inflation is running at a bit over 4 per cent," she observed.
"So it's above our target and it's pretty sticky. And that's what we're observing overseas as well.
"So we've got a slowdown in the economy, we've still got inflation a bit sticky.
"And we've also got housing prices increasing, again, which usually gives people a little bit of confidence, you know, their wealth increasing
"We've still got a very tight employment market — there are signs that that the labour market is turning, but the labour market is still very tight — and that's putting pressure on wages.
Ms Bullock said the rapid rebound in home prices across much of the nation was something the Reserve Bank had not expected.
"The housing market has surprised me a bit," she said.
"When interest rates started to rise, housing prices started to decline and we thought they would continue to decline.
"But, actually, they bottomed sooner than we thought and basically now they're back to where they were in their peaks of the pandemic."
She said the surge in construction costs and a jump in rents had offset some of the effect of rising interest rates on whether buying a home looked financially attractive.
'Shock, after shock, after shock'
She also noted that events well beyond the RBA's control continued to put upward pressure on key prices globally, such as fuel costs, which have risen sharply on the Israel-Gaza war.
Ms Bullock is worried that repeated price rises from supply shocks will eventually embed higher inflation over the longer term.
"The problem is that we've just got shock, after shock, after shock," she said.
"And the more that that keeps inflation elevated, even if it's from supply shocks, the more people adjust their thinking. And the more people adjust their inflation expectations, the more entrenched inflation is likely to become."
If long-term inflation expectations did become entrenched at higher levels then Ms Bullock warned the Reserve Bank would have no alternative but to raise interest rates further, potentially aggressively, to ensure that price rises came back to targeted levels.
"Most people believe that central banks will do what it takes to get inflation back down to 2-3 per cent," she said.
"But the longer inflation stays above target and the more people observe it happening in their day-to-day lives, the harder it will be."