RBA Governor Philip Lowe discussed “Regional Variation in a National Economy” today in an address to the Australia-Israel Chamber of Commerce (WA). It is worth reading, not least because of the regional variations he highlights. However, the section on monetary policy piqued my interest.
In particular, that the next cash rate move is likely to be up. Recently a number of pundits have started to say there will be a cut. Perhaps not!
The Reserve Bank’s responsibility is to set monetary policy for Australia as a whole. We seek to do that in a way that keeps the national economy on an even keel, and inflation low and stable. No matter where one lives in Australia, we all benefit from this stability and from being part of a national economy. This is so, even if, at times, in some areas, people might wish for a different level of interest rates from that appropriate for the national economy. In setting that national rate, I can assure you we pay close attention to what is happening right across the country.
As you are aware, the Reserve Bank Board has held the cash rate steady at 1½ per cent since August 2016. This has helped support the underlying improvement in the economy that I spoke about earlier.
In thinking about the future, there are four broad points that I would like to make.
The first is that we expect a further pick-up in the Australian economy. Increased investment and hiring, as well as a lift in exports, should see stronger GDP growth this year and next. The better labour market should lead to a pick-up in wages growth. Inflation is also expected to gradually pick up. So, we are making progress.
There are, though, some uncertainties around this outlook, with the main ones lying in the international arena. A serious escalation of trade tensions would put the health of the global economy at risk and damage the Australian economy. We also have a lot riding on the Chinese authorities successfully managing the build-up of risk in their financial system. Domestically, the high level of household debt remains a source of vulnerability, although the risks in this area are no longer building, following the strengthening of lending standards.
The second point is that it is more likely that the next move in the cash rate will be up, not down, reflecting the improvement in the economy. The last increase in the cash rate was more than seven years ago, so an increase will come as a shock to some people. But it is worth remembering that the most likely scenario in which interest rates are increasing is one in which the economy is strengthening and income growth is also picking up.
The third point is that the further progress in lowering unemployment and having inflation return to the midpoint of the target zone is expected to be only gradual. It is still some time before we are likely to be at conventional estimates of full employment. And, given the structural forces also at work, we expect the pick-up in wages growth and inflation to be only gradual.
The fourth and final point is that, because the progress is expected to be only gradual, the Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy. While some other central banks are raising their policy rates, we need to keep in mind that their economic circumstances are different and that they have had lower policy rates than us over the past decade, in some cases at zero or even below. A continuation of the current stance of monetary policy in Australia will help our economy adjust and should see further progress in reducing unemployment and having inflation return to target.
