Lowe pulls the rug out from under Morrison’s interest rate scare campaign

Reserve Bank governor Philip Lowe’s speech on inflation yesterday was drafted well ahead of Scott Morrison’s comments about how the Coalition would keep interest rates lower than Labor. Indeed, much of the monetary policy content of the speech was a repackaging of Lowe’s media conference on November 2 and the minutes of the RBA board meeting of that day. So he can’t be accused of being political in his comments.

Nonetheless it pointed to a stark distinction between the adults in the room of economic policymaking in Australia and a desperate prime minister looking for a scare campaign.

Morrison’s accusation is that Labor will somehow force interest rates higher than they should be — presumably by spending an even bigger proportion of GDP than the 26-27% Morrison is spending, or by managing the economy more successfully so that growth picks up quicker.

But Lowe’s point is that interest rates will go nowhere until wages growth is up in the 3% range and forces inflation sustainably up above 2%. And they’ll go nowhere despite the conniptions of bond markets, the commentary of inflation hawks and the demands of neoliberals in places like The Australian Financial Review.

Just to make it absolutely clear, Lowe waited right until the end of the speech, and said: “I would like to repeat a point I made a couple of weeks ago — that is, the latest data and forecasts do not warrant an increase in the cash rate in 2022. The economy and inflation would have to turn out very differently from our central scenario for the board to consider an increase in interest rates next year.”

How’s that for clarity, bond bunnies, and an implied rebuke of a prime minister warning that rates will go up under Labor.

Lowe and the bank are unfazed about current inflation levels. He walked through what’s driving inflation in Australia compared with the rest of the world, pointing out commonalities and differences. An important point was that the pandemic and its aftermath have posed a fundamental challenge for what has been a default setting in global manufacturing and logistics for decades — just-in-time supply chains that rely on low inventories but time-effective distribution. These proved vulnerable to the impacts of the pandemic, and to the volatility in demand caused by lockdowns and their ending.

But Lowe also explained that that volatility means the current high levels of demand — from consumers spending money saved during the pandemic — is likely to return to normal as those reserves are exhausted, and the shift in consumption during lockdowns — from services to goods — is likely to revert as well, relieving demand-side pressures.

As opposed to the United States and the UK, where labour market pressures are driving big wages growth which could well feed into inflation, in Australia we’ve seen no such growth.

Lowe understands something bond markets and the AFR do not: that as households’ lockdown savings are exhausted, and with no expectation that wages will rise, consumers will cut spending again. In Lowe’s view, it was likely wages growth needed to be above 3% to get inflation back to the middle of the RBA’s 2%-3% target band.

“We are using wages growth as one of the guideposts in assessing progress towards our goal and whether inflation is sustainably in the target range,” Lowe said.

Even then, “this, by itself, does not warrant an increase in the cash rate. As I have said, much will depend upon the trajectory of the economy and inflation at the time.”

Maybe that’s what Morrison is warning Australians about — that Labor might lift wages growth above 3% for the first time in a decade, prompting the RBA to finally lift rates.