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Philip Lowe says higher rates ‘necessary’ to slay 7pc inflation

John KehoeEconomics editor

Reserve Bank of Australia governor Philip Lowe says inflation will peak at a “very high” 7 per cent late this year, but an extra $250 billion of savings will help households contend withcost of living pressures and falling house prices.

Dr Lowe said it was “reasonable” to expect the cash rate to eventually reach 2.5 per cent, in line with the midpoint of the inflation target, but he admitted it was “unclear” how high rates would go and how quickly.

RBA governor Philip Lowe says the economy will remain “pretty strong”. Louie Douvis

He said higher interest rates were required because there was too much “spending pressure” and the time for emergency pandemic settings was over.

“When there’s a lot of pressure on capacity, prices go up and higher interest rates will establish a better balance between spending and the ability of the economy to produce goods and services,” Dr Lowe said in an interview on Tuesday night with the ABC’s 7.30 television program.

The RBA imposed a super-sized 0.5 of a percentage point rate rise last week, to take the cash rate to 0.85 per cent.

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While rate rises would be difficult for some borrowers, Dr Lowe said savers would welcome the higher returns after years of near-zero interest rates.

Dr Lowe said he was not worried about falling house prices in capital cities such as Sydney and Melbourne because the central bank did not target house prices.

Eye on consumer spending

However, he admitted the RBA would keep a close eye on the impact on consumer spending from falling house prices, after national house values increased 25 per cent since the start of the pandemic.

“We know that swings in housing prices affect people’s consumption decisions.

“Many people feel if the value of their house has fallen, they’re going to spend a bit less.

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“We’ve got to remember as well that households have saved this extra $250 billion and the current rate of savings is very high.

“And unemployment is low and the number of job vacancies at the moment is extraordinarily high.

“So there are a lot of other factors that are influencing consumption other than housing prices and our job is to work out what the balance is amongst all those factors.”

Despite speculation about a potential US recession, Dr Lowe said he expected the Australian economy to remain “pretty strong” over the next six to 12 months.

The RBA now expects inflation to hit 7 per cent late this year, up from its previous forecast peak of 6 per cent.

Dr Lowe said he expected global inflation pressures to ease from early next year, such as the high global oil price and pandemic-induced supply chain disruptions, with manufacturers of cars and computers chips already ramping up production.

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“I think eventually it will come down and partly it will come down because of the global factors,” Dr Lowe said.

“Over the past year, petrol prices in Australia have gone up over 30 per cent.

“So even if the current level of petrol prices stays where it is, the rate of change goes from 30 per cent to zero and that will help bring down the headline rate of inflation.

“Another thing that’s going to help is that the supply side problems in the global economy being resolved.

“So inflation will come down for those reasons but it will also come down because of the higher interest rates.”

Dr Lowe said he was not worried about a potential lack of alignment of the bank’s monetary policy and the government’s fiscal policy, after meeting twice recently with Treasurer Jim Chalmers.

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Treasury is forecasting an $80 billion budget deficit and gross debt of more than $1 trillion.

Dr Lowe said the “biggest fiscal issue” was paying for the higher spending the community expected on disability, aged care, healthcare and defence.

The options to afford the spending were growing the economy “very strongly so that the pie is bigger and serving more funding for everything.

“That’s the best option and other options are to cut back in some others, but that’s pretty hard, isn’t it?

“And the third option is to raise more revenue through higher taxes and that comes with complications as well.

“So that’s the biggest fiscal issue.”

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Asked if the bank and government “overstimulated” the economy during the pandemic, Dr Lowe said during the early dark days of the pandemic, experts were predicting tens of thousands of deaths, hospitals being overrun, 15 per cent unemployment and economic and social scarring.

“We took out a lot of insurance,” Dr Lowe said.

“I think it was the right thing to do. But I accept that others will have a different view and the Reserve Bank is committed to learning from that experience.

“We’re undertaking a series of reviews about how we responded and through that period and we’ll publish those in the coming months.

“But we took out insurance, maybe we took out too much.

“But in the time that we faced the decisions we had to take, I think it was the right thing to do.”

John Kehoe is Economics editor at Parliament House, Canberra. He writes on economics, politics and business. John was Washington correspondent covering Donald Trump’s election. He joined the Financial Review in 2008 from Treasury. Connect with John on Twitter. Email John at [email protected]

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  • Interest rates
  • Philip Lowe
  • RBA

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