Reserve Bank of Australia Not ‘Inflation Nutters’, Lowe Says in First Speechby
Flexible inflation target remains right policy for Australia
Governor Lowe says lower Aussie dollar ‘would be helpful’
Reserve Bank of Australia Governor Philip Lowe said it was unlikely the central bank would resort to unconventional measures and that a flexible inflation target that took account of financial imbalances was the most appropriate way to decide policy.
Lowe said the Australian economy was “not at all” running out of options and there was a strong case for infrastructure spending to support growth, in reply to questions on the limits of monetary policy from a parliamentary committee in Sydney Thursday. The central bank, which has cut the benchmark to a record low 1.5 percent, has previously indicated that rates become less effective at about 1 percent.
It’s “very unlikely we will be in a situation where we confront highly unconventional monetary policy,” said Lowe. “But we do have options, as other countries have options.”
The governor reinforced the flexibility of the RBA’s 2-3 percent inflation target and said his colleagues hadn’t been “nutters” when it came to meeting the goal, while reiterating the importance of elevating financial stability in policy making. The bank doesn’t see its job as always keeping inflation “tightly in a narrow range” and a degree of variability in inflation “from year to year is both inevitable and appropriate,” he said.
Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada in Sydney, said it was “noteworthy” that financial stability was “creeping more forcefully into the policy debate. It suggests a greater tolerance for sub-target inflation and a patient central bank.”
Lowe’s remarks provided an upbeat assessment of the economy he inherited this week: While interest rates and wage growth are at record lows, reflecting anemic inflation, economic growth is above average and unemployment at a three-year low. The central bank has cut borrowing costs twice since May to try to cap a currency supported by negative rates and bond-buying programs from Europe to Japan and a Federal Reserve hesitant to tighten.
While such actions “have generally not been taken with the direct intention of influencing exchange rates, they have, inevitably, affected international capital flows and exchange rates,” Lowe told the House Economics Committee. “The monetary expansion elsewhere and the low rates on offer overseas have meant that foreign investors have found Australian assets, with their relatively higher returns, attractive. In this way, what is happening elsewhere affects us here in Australia.”
The Aussie has climbed more than 11 percent since a mid-January trough, hampering the economy’s transition to growth driven by services as a mining investment boom unwinds. The key education and tourism industries are hyper-sensitive to the currency and had received a tailwind from a more than 25 percent depreciation since the start of 2013.
“A lower exchange rate would be helpful,” Lowe said in response to a question. “But of course we all can’t have one.” The recent rise in the Aussie partly reflects higher commodity prices and the yield on offer in Australia, he said.
Lowe said it was unclear how negative interest rates elsewhere in the world would play out, but that there were better ways to stimulate economies.
Fed Chair Janet Yellen overnight resisted pressure to tighten policy, saying the U.S. economy has a little more room to run. Hours earlier, Bank of Japan Governor Haruhiko Kuroda adopted a pledge of "overshooting" its 2 percent inflation target and unveiled a strategy of targeting short- and longer-term rates to provide the economy with cheap borrowing costs.
Australia’s economy is enjoying an unexpected fillip from a 30 percent jump in the price of commodity exports compared with their trough earlier in the year as Chinese high-cost producers cut output of bulk commodities. That prompted a turnaround in the terms of trade, or the ratio of export prices to import prices, that is a key determinant of national income.
Commodity prices had slumped in recent years as weaker Chinese demand for metals like iron ore to build bridges and skyscrapers combined with increased supply.
“While it is difficult to predict the future, if these increases were to be sustained then we could look forward to the drag on national income from falling commodity prices coming to an end,” said Lowe.
The RBA’s rate cuts have spurred the housing markets in Sydney and Melbourne, leading some observers to warn of bubble-like conditions. Lowe said the outlook is improving following regulatory measures to curb lending to investors and as new stock comes in line.
“The construction cycle has a bit more momentum than we expected earlier,” he said. “Credit growth and turnover in the housing market are also lower than they were a year ago. Under APRA’s guidance, lending standards have also been tightened. Overall, then, the situation is somewhat more comfortable than it was a year ago, although we continue to watch things carefully.”
Traders are pricing in little chance of the RBA raising rates this year, with just over 25 percent in December, though bets rise to around 50 percent by the middle of next year.