Reserve Bank governor Michele Bullock told a closed conference more aggressive interest rate rises may be needed to bring down inflation and stop it becoming entrenched.
A week after the RBA hiked rates for the fourth time this year, the RBA’s annual Chatham House rules conference on monetary policy trade-offs was told a gradual tightening of monetary policy may be insufficient.
Ms Bullock made some opening remarks to that conference on October 8 and 9, held in Sydney, based on a paper she co-wrote with the RBA’s senior research manager Anthony Brassil, that was released a week later on Friday.
“To bring inflation back to target in a timely way, monetary policy may need to be tightened – but that weakens demand in the near term,” she said.
“A more gradual disinflation may reduce the immediate demand costs but prolongs the costs of inflation, and increases the risk that inflation becomes embedded in expectations and behaviour.”
The two-day RBA conference was held 10 days after the Reserve Bank’s monetary policy board voted unanimously to raise the cash rate to a 15-year high of 4.6 per cent.
Ms Bullock’s opening remarks also suggested inflation could take longer to return to its 2-3 per cent target, with the RBA releasing updated forecasts on November 3, coinciding with its next interest rate decision.
“There is no mechanical rule that tells a monetary policy board exactly how quickly inflation should return to target in every circumstance,” she said.
“Models, forecasts and empirical estimates are essential inputs, but ultimately decisions require judgement.
“The purpose of this conference was to help sharpen that judgment.”
The RBA chief also suggested unemployment may already be starting to keep increasing as higher interest rates weakened the labour market.
“At the same time, weaker activity may mean that unemployment and underemployment are already increasing,” she said.
Westpac chief economist Luci Ellis, a former RBA assistant governor, said expectations of inflation staying higher were likely to see firms pass on higher costs to customers.
“Firms form expectations and set prices according to what is happening in their own industry and experience, while putting little weight on economy-wide inflation or central bank credibility,” she said.
“This is an unpleasant message for many consumers or anyone in an interest-sensitive sector when supply shocks abound.”
Dr Ellis also argued that the RBA’s ban on surcharging or charging customers for costs unrelated to electronically processing a transaction, could see a minority of cafes put up their prices in other ways.
“Some firms have lifted their prices by more than any reasonable estimate of the merchant service fee that the surcharge was meant to cover and because this is Australia, of course takeaway coffee has been the centre of consumer discontent,” she said.
“Not all firms can pass on cost increases. Most small firms do not have the market power, though coffee may be an exception because convenience induces a kind of local market power.”
Market pricing for another hike on November 3, shortly before the Melbourne Cup, fell from 27 per cent to 16 per cent after the Australian Bureau of Statistics on Thursday revealed unemployment in September rose to a five-year high of 4.7 per cent, with 39,300 jobs lost.
This was worse than market forecasts of unemployment last month holding steady at 4.6 per cent as 19,600 jobs were created.
But bond markets are still expecting another hike with the two and-three year Australian Government bond yields at 4.9 per cent, implying another increase that would take the Reserve Bank cash rate to an 18-year high of 4.85 per cent.
Headline inflation in August rose to 4 per cent, putting it above the RBA’s target band for the 13th straight month while underlying inflation without volatile items also remained elevated at 3.6 per cent.