Philip Lowe, governor of the Reserve Bank of Australia (RBA), just outlined what he’s looking at when deliberating interest rates.
Speaking in Sydney at Citibank’s Annual Australian and New Zealand Investment Conference earlier today, Lowe said that while recent factors that have led to weak inflationary pressures “will continue for a while yet”, he acknowledged that “this does not mean that we have drifted into a world of permanently lower inflation in Australia”.
Providing confidence to Lowe that inflation in Australia will pick up over the next couple of years, he noted that “domestic demand is expected to strengthen gradually as the drag on our economy from the decline in mining investment comes to an end”.
“As this happens, the excess capacity, including in the labour market, is likely to be wound back,” he said.
“Some pick-up in wages and prices could then be expected.”
He also said that recent strength in commodity prices, if sustained, “will boost national income”. Accompanied by a pickup in petrol prices, he suggested that it “will no longer be having a significant effect on headline inflation”.
Lowe also acknowledged that he was conscious that low interest rates also meant “low returns for many savers”, and made no specific mention of the Australian dollar other than that recent strength in commodity prices had placed upward pressure on the currency.
Again, hardly a view that one would associate with a near-term desire to cut interest rates.
While Lowe appears confident in the outlook for inflation and economic activity, he acknowledged that when it comes to the outlook for interest rates, what matters most to the RBA is what is in the public’s interest.
“When we find ourselves with inflation that is either lower, or higher, than normal, we want to feel confident that, over time, inflation will return to more normal levels,” he said.
“There is, however, always a choice about the exact path we take.
“When thinking about that choice, developments in the labour market and in balance sheets in the economy have particular importance,” he added.
This, said Lowe, is what’s important when it comes to monetary policy deliberations.
In other words, monetary policy is not just aimed at trying to get inflation back within the bank’s 2-3% target band as quickly as possible. There are other factors to consider, he said.
“A flexible medium-term inflation target, paying close attention to the labour market and keeping a wary eye on balance sheets in the economy is the best way of doing this,” he said, adding that in his view “it remains the right monetary policy framework for Australia”.
That provides a fairly obvious hint that, under Lowe’s tenure as governor, the outlook for interest rates will not merely be about how the quarterly inflation figure prints, but will also consider what is happening in the labour market and household balance sheets, particularly around the residential property market.
So what are the things that Lowe is watching closely when it comes to the outlook for inflation, the labour market and housing?
Thankfully, he spoke on each of these topics briefly, providing an indication to financial markets, households and businesses as to what could potentially shift interest rates in the period ahead.
On inflation, he said that he was looking carefully at the various measures of expectations, adding that the RBA needed to guard against expectations falling too far as “if this were to occur it would be more difficult to achieve the inflation target”.
Suggesting that next week’s Q3 CPI release is still of importance, he noted that “one of the key influences on inflation expectations is the actual outcomes for inflation”.
On the labour market, he said that the picture was “mixed”, with a decline in the unemployment rate accompanied by “weak” growth in hours worked and an increase in underemployed workers – those who are currently working but who would like to work more.
Importantly, he also stated that while wage pressures remained weak, “there are some signs that the downward pressure on average wages from workers moving out of high-paying mining-related jobs might be coming to an end”.
Finally, on the housing market, he admitted what most of us already know: that it is a “complex picture”.
“Prices seem to be increasing quite briskly again in some areas, although are falling in others,” he said. He also provided a guarded warning to property investors, suggesting that “growth in rents is very low and there is a big increase in housing supply still to come”.
A not-so-subtle hint that if capital appreciation were to slow or reverse, gross rental yields don’t offer much of a return based off current evidence.
Adding to to heightened levels of uncertainty, he noted that “credit growth is still exceeding income growth, although by a smaller margin than last year”, adding that it was “noteworthy that much of this credit is being used to finance new housing construction rather than consumption”.
So we now have a fairly good indication on what to watch in the months ahead, at least from a domestic perspective: inflation readings, not only actual but also expectations, labour market data, especially measures on labour market slack, and house price and housing credit growth.
Of course, outside of domestic factors, monetary policy from major central banks — particularly the US Fed — along with the performance of the Chinese economy, will be key influences on future policy decisions from the RBA moving forward.
We’re about to get a lot of information on those fronts in the week ahead, with Chinese GDP along with Australian employment and consumer price inflation data all on tap.
Market reaction to the speech has been muted, signalling that while investors believe a rate cut from the RBA is unlikely near-term, it cannot be completely ruled out.
You can read Lowe’s speech in full here.
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