Reserve Bank of Australia governor Michele Bullock warns of inflation impacts from continued supply shocks

Reserve Bank governor Michele Bullock says the economic environment is “challenging”, warning while interest rate rises are “starting to bite”, the potential for entrenched inflation was increasing due to consistent supply shocks.

Ms Bullock on Wednesday said inflation was still high at a time when the economy was starting to slow, the jobs market was still tight but loosening and house prices were rising again, which typically gave people confidence.

The new governor, who took over the top job last month, agreed her predecessor Philip Lowe did “cop a lot” but was eventually toppled as public enemy number one.

“One of the things about the independence of the Reserve Bank, and I’m sure Phil would, I think he said this, and he would concur with it, is that because we are... independent of the government, we can take difficult decisions. And yes, he did cop a lot. And I think he got knocked off, though, by Alan Joyce,” she said.

She also said she had noticed — and “I’m sure you’ve noticed” — a recent spike in petrol prices, even immediately prior to the war in Israel due to higher oil prices. The combat was “likely to keep oil prices elevated as people are a little usnure about how it’s going to impact the supply of oil”.

“Now what we’ve got is services inflation — inflation in things like take-aways, hairdressers, restaurants, those sorts of things” she told the Australian Financial Security Authority summit in Sydney on Wednesday. “That inflation is running at a bit over 4 per cent, so it’s above our target and it’s pretty sticky.”

The Reserve Bank’s inflation target is 2 to 3 per cent and the bank has been pushing rates higher in an effort to get the inflation rate back there. Minutes of its October meeting, released on Tuesday, state the bank has a “low tolerance” for inflation staying above target for too long.

“We have to alert people that if inflation continues to be higher than expected and the risks are on the upside, then we’re going to have respond with monetary policy (interest rates),” Ms Bullock told the summit. “That’s what we need to make people understand.

“The longer inflation stays above target and the more people observe it happening in their day-to-day lives, the harder it will be. We think we’re running that narrow path at the moment but we’re very alert to the upside risks.”

“It’s a real balance here at the moment ... some people are hurting, consumption is slowing at the same time you’ve got these other factors potentially keeping inflation a little bit sticky and a little bit elevated.”

“As the bank what we’re trying to do ... we’re trying to bring inflation back down in a reasonable amount of time while preserving employment gains by not really bringing the economy to its knees so lots of people get unemployed.

“We’re trying very much to do it in a way that preserves the employment gains,” she said, referring to the unemployment rate being below 4 per cent since early last year — the lowest it’s been since 1974.

War in Israel and other places had the potential for economic impacts on Europe, which would slow the world economy, Ms Bullock said — and there were “potential inflation implications”.

Typically supply shocks were economically considered OK as they would “wash out” of the system, she said.

“The problem (now) is that we’ve just got shock after shock after shock and the more that keeps inflation elevated, even if it’s from supply shocks, the more people adjust their thinking ... (and) the more entrenched inflation is likely to become,” she said.

Ms Bullock said while consumption per person was down but consumption was stable due to population growth. Discretionary goods and services were what people were cutting back on — though in WA, according to Deloitte, spending on those items is holding up.

A further pullback was expected, she said, given the full impact of rate rises to date had yet to be felt.

“People have smaller basket sizes, so they’re buying less than they did, or they’re trading down to home brand or something like that,” she said. “There’s signs that people are taking measures at the margin, and this would be particularly, I think the case, for people being impacted by higher interest rates — if they want to make their mortgage payments, they’re going to have to cut back on some discretionary spending.

“There is a group of people that really are hurting here and that’s going to be very challenging for them.”

Ms Bullock said one of key watchpoints for the local economy over coming months as pressure grew was whether Australians used more of the $300 billion in aggregate savings accumulated during the pandemic.

“That really hasn’t been run down yet,” she said. “It’s actually the million-dollar question: will they run it down or will they regard it as ... part of wealth.

“There doesn’t seem to be this wholesale, at the moment, spending of all this money I’ve suddenly got in my account. A lot of those savings are in offset and redraw accounts.

“People have a tendency to want to pay off their mortgages more quickly. If anything, with higher interest rates on their mortgages at the moment, holding those savings in those offset and redraw accounts is actually very beneficial for them.”

Ms Bullock said while there was “a certain portion of the community” that was “very hurt” by rising interest rates, it was also true that there was a large portion not affected by rising rates, and some had even benefited from the increases.

“Rises in interest rates, they impact people in different ways, they have distributional impacts,” she said. “We can’t impact that, the government can address those sorts of things.”