Governor Philip Lowe spoke in Adelaide last night.
He highlighted ongoing low inflation and wages growth, despite a pick-up in business investment, as well as continuing high household debt, and the prospect that the next rate move will likely be up.
I am still amazed that household credit is still being allowed to run on at 3x income/cpi. So, I question his statement that “things now look less worrying than they were a while back” on this front! Household debt has NEVER been higher.
As you are aware, at our meeting today, the Board kept the cash rate unchanged at 1½ per cent. It has been at this level since August 2016 – that is for 21 months – which is the longest period without a change.
At today’s meeting, when we measured the pulse of the Australian economy, we assessed it to be stronger than a year ago. Business conditions are around their highest level for many years and the long-awaited pick-up in non-mining business investment is taking place. There has been a large pick-up in infrastructure spending in some states. The number of Australians with jobs has also grown strongly over the past year. The unemployment rate is lower than it was a year ago, although there has been little change for the past six months. Growth in consumer spending has been solid, although it is lower than it was before the financial crisis.
At our meeting today, we also discussed the latest inflation data, which showed that both CPI and underlying inflation were running marginally below 2 per cent. This was in line with our expectations and provides further confirmation that inflation has troughed, although it remains low. Strong competition in retailing is holding down the prices of many goods: for example, over the past year, the price of food increased by just ½ per cent, the price of clothing and footwear fell 3½ per cent and the price of household appliances fell 2½ per cent. Importantly, these outcomes are helping to offset some of the cost of living pressures arising from higher electricity prices, which nationally are up 12 per cent over the past year.
Another factor influencing recent inflation outcomes is the subdued growth in wages. Increases in wages of around 2 per cent have become the norm in Australia, rather than the 3–4 per cent mark that was the norm a while back. This is an issue we have been discussing around our board table for some time. While low growth in wages has helped boost employment, it has also put the finances of some households under strain, especially those who borrowed on the basis that their incomes would grow at the old rate. And in terms of the inflation target, it is difficult to see how a continuation of 2 per cent growth in wages is compatible with us achieving the midpoint of the inflation target – 2½ per cent – on a sustained basis. So from that perspective alone, a pick-up in wages growth over time would be welcome. Perhaps more importantly, sustained low wages growth diminishes the sense of shared prosperity that we have in Australia.
In our liaison with businesses, including here in Adelaide, many tell us about the very competitive environment in which they are operating. They tell us about how this competitive environment means that they have limited ability to pay bigger wage increases. At the same time, though, we are hearing a few more reports of larger increases in those areas where there is a shortage of workers with the necessary skills. After all, the laws of supply and demand still work. We also see evidence in the aggregate data that wages growth has troughed and we expect to see a further pick-up. This is likely to be a gradual process, though.
At today’s meeting, the Board also reviewed the staff’s latest forecasts for the economy. These will be published on Friday in our quarterly Statement on Monetary Policy. Those of you who are close readers of this document will notice some changes in this issue, as we seek to make the report more thematic.
The latest forecasts should not contain any surprises, with only small changes from the previous set of forecasts, issued three months ago. This year and next, our central scenario remains for the Australian economy to grow a bit faster than 3 per cent. This would be a better outcome than the average of recent years. If we are able to achieve this, we will make inroads into the remaining spare capacity in the economy and see a further modest decline in the unemployment rate. Inflation is expected to remain low, at around its current level for a while yet, before gradually increasing over the next couple of years, towards 2½ per cent. A key element here is the pick-up in wages growth that I just mentioned.
So, in summary, there has been progress in lowering unemployment and having inflation return to around the middle of the target range, and we expect further progress in these two areas over the next couple of years.
The other key point is that the progress we are making is only gradual: our central scenario is for a gradual pick-up in wages growth, a gradual lift in inflation, and a gradual reduction in the unemployment rate. While we might like faster progress, it is encouraging that things are moving in the right direction and are likely to continue to do so.
If this is how things turn out, it is reasonable to expect that the next move in interest rates will be up. This would reflect conditions in the economy returning to normal. In our discussions today, though, the Board again agreed that there was not a strong case for a near-term adjustment in the cash rate. This reflects our view that the progress in moving towards full employment and having inflation return to the middle of the target range is likely to be only gradual. The Board’s view is that while this progress is occurring, the best contribution we can make to the welfare of the Australian people is to hold the cash rate steady and for the Reserve Bank to be a source of stability and confidence.
Domestically, for some time, we have seen the main risk to be related to household balance sheets. For a while, trends in household credit were quite concerning. On this front, things now look less worrying than they were a while back, although the level of household debt remains very high, which carries certain risks. In terms of financing, we also discussed the potential for some tightening in financial conditions in Australia. In the United States, the cost of US dollar funding has increased for reasons not directly related to monetary policy and this increase is flowing through into higher money market rates in Australia. We expect some of this to be reversed in time, although it is difficult to tell by how much and when. It is also possible that lending standards in Australia will be tightened further in the context of the current high level of public scrutiny. We will continue to watch these issues carefully.
