MNI ANALYSIS: Lowering Inflation Target Not An RBA Option Now

--Lifting Wage Expectations Remains RBA's Main Monetary Policy Strategy

By Sophia Rodrigues

     SYDNEY (MNI) - It is unlikely the Reserve Bank of Australia will consider

lowering its inflation target over the next few years as it would be completely

at odds with the their current policy strategy of lifting wage expectations,

despite some merit in the argument that low inflation outcomes in recent years

have been partly due to structural reasons. 

     Inflation outcomes in Australia have fallen short of the mid-point of the

RBA's 2% to 3% target band for a few years now, and the latest Statement on

Monetary Policy shows the RBA expects this trend to continue until the end of

the forecast period -- December 2020 -- when it expects inflation to be just

2.25%.

     This has led to some renewed interest in the debate that the RBA should

lower the inflation target and aim at 2% as the mid-point, bringing them in line

with other central banks like the Reserve Bank of New Zealand, Bank of Canada

and the Federal Reserve.

     --PATIENT WITH LOW INFLATION

     In a Q&A session following a speech last week, Governor Philip Lowe said

the RBA has no plan to review the inflation target anytime soon. Lowe pointed to

academic debate for raising the inflation target, rather than lowering it, but

mainly talked about the benefits the long period of inflation targeting has

achieved, and the risk that changing it would de-anchor inflation expectations.

     But more than the risk of de-anchoring inflation expectations, any lowering

of the inflation target now would clash with the RBA's strategy to lift wage

expectations. This is because it is not just inflation, but also the RBA growth

forecasts, that are reliant on accelerating in wages growth.

     The RBA has been tolerant of low inflation in recent years and Lowe keeps

talking about continued patience, so in a sense their acceptance of said could

be regarded as a de facto acceptance of a lower target. Further Lowe admitted at

the ECB's Sintra forum in June that the system looks less inflation prone that

it once was due to reasons including technological progress.

     But none of that means the RBA is ready to start a conversation about

officially lowering the inflation target.

     --LIFTING WAGE EXPECTATIONS VERY IMPORTANT 

     Lifting wage expectations is clearly an important strategy and one that is

unique to the RBA. 

     Lowe's main worry has always been that the low wage outcomes in recent

years would lead to falling wage expectations. So one part of his monetary

policy strategy has been lifting wage expectations, with the other supporting

growth via accommodative monetary policy. Lowe hopes that stronger growth would

eventually lead to a shift in labor demand-supply, and on to a gradual lift in

wages. And he knows that for that to happen, wage expectations can't fall too

far.

     Household consumption also remains a key element underpinning the RBA's

growth forecast, and an acceleration in wage growth is important as it boosts

household income and thus spending. 

     In an environment of highly-indebted households, alongside slowing or

declining housing prices, wage growth is needed to do the heavy lifting as far

as consumption goes, as households can no longer rely on rising housing prices

to support consumption.

     It is likely the RBA will pursue their strategy of raising wage

expectations until they see increases that would support their household

consumption forecasts. Any debate about lowering inflation target would,

therefore, be at odds and undo the RBA's efforts in this direction.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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