MNI: RBA's Lowe Says Narrow Inflation Targeting Getting Harder

Reserve Bank of Australia Governor Philip Lowe warned of more variability in prices triggered by supply-side challenges and pointed to the increasing difficulty of targeting a narrow range of inflation in a speech on Tuesday.

Two weeks from the RBA's final meeting for the year, Lowe said the central bank expects to increase interest rates over "the period ahead", though it was prepared to revert back to 50bp hikes or pause depending on economic data. Policymakers would pay "close attention" to global economic developments, household spending, and wage and price-setting behaviour. The RBA is expected to hike rates 25bp to 3.1% on Dec 6. (See MNI RBA WATCH: Hikes 25bp, To Miss Inflation Target Until 2025)

The Governor said increased supply-side challenges were likely to play a "more prominent role" in inflation outcomes over coming years, adding "it is increasingly problematic to set a narrow range that inflation is always supposed to be within." The RBA targets inflation between 2-3%, significantly lower than the 8% peak in inflation it has forecast for later this year. (See MNI BRIEF: RBA Ups Key Inflation Forecast As Energy Costs Soar)

FOUR BIG TRENDS

Lowe identified four main supply-side concerns - the reversal of globalisation, demographics, climate change, and energy transition - as likely to "create more variability in inflation than we have become used to." He said the global supply curve had become less elastic than it has been over the past decade.

Amid a Treasury-led review of the RBA's policy formulation and implementation, he declared the RBA's medium-term inflation target, and its flexibility, was "appropriate", though it was "worthy of examination" as part of the ongoing review. The RBA review panel will provide an update on Thursday. (see MNI BRIEF: RBA Review To Leave No Stone Unturned)

The monetary policy framework though continues to require a strong nominal anchor, he said.

"Without a strong nominal anchor, expectations of inflation will adjust when inflation is away from the target range, making it harder to return to target."

Lowe said it was important that the supply side of Australia's economy was flexible, especially in labour and product markets. He also noted the importance of flexibility in fiscal policy, which required "maintaining a strong underlying structural budget position."