Reserve Bank governor Michele Bullock delivered a stark warning Tuesday that interest rates could rise further if inflation doesn't return to target, even as housing markets show unexpected weakness and unemployment ticks higher. Speaking to the Anika Foundation in Sydney, she said the central bank stands ready to act as required to achieve its inflation mandate.
Headline inflation remained at 4 per cent in May, well above the RBA's target range. That's why the bank tightened monetary policy earlier this year and why Bullock's prepared to do more. "If inflation keeps rising from here, the RBA's Monetary Policy Board would be prepared to lift interest rates even higher if necessary," she said in her speech titled Monetary Policy in an Era of Shocks.
The Productivity Problem
Bullock identified weak productivity growth as the fundamental challenge facing Australia's economy over the next few years. She warned that with continued weak productivity growth, Australia's economy wouldn't be capable of growing strongly without putting upward pressure on inflation. That'll limit policymakers' choices going forward.
The governor said monetary policy can't address Australia's slow productivity growth, and while the problem persists, workers would probably keep experiencing limited growth in real wages. Persistently weak productivity has been weighing on real incomes and wages for years already, she noted.
Housing Market Softens More Than Expected
The housing market has been weaker than the RBA anticipated in recent months. Bullock said the bank expected conditions to ease in response to the changed outlook for monetary policy and the rise in the cash rate earlier this year, but the housing market eased by more than anticipated in May.
This appeared to reflect a range of factors, including recent policy developments affecting the housing market and a general softening in housing market sentiment. Price declines have been concentrated in the Sydney and Melbourne markets, though prices in those markets remained around where they were before interest rates started to rise in February this year.
The easing in established housing prices has been modest after a period of strong growth. The most recent data suggested negative equity remained very limited, affecting less than 1 per cent of borrowers. Bullock emphasized that while the RBA expected property prices to be affected when interest rates rise, monetary policy didn't target housing prices. What mattered for monetary policy was how changes in housing prices affected household spending, investment decisions and, ultimately, inflation.
Labour Market Cooling Faster
The labour market has also eased more than expected in recent months, with the unemployment rate rising faster than anticipated. The national unemployment rate currently sits at 4.4 per cent. The RBA is forecasting it to reach 4.6 per cent by the end of next year.
Bullock said the labour market probably needed more unemployment or underemployment to bring inflation back down. Some further easing in labour market conditions would likely be required to bring inflation back to target, she said.
Global Shocks Complicate Policy
Bullock warned that the world has become more shock-prone in recent years and that adverse supply shocks can constrain growth, reduce real incomes and add to inflationary pressures. The RBA's job was to keep inflation expectations anchored and make sure shocks don't lead to lasting increases in inflation.
She said the latest spike in oil prices was another complication for monetary policy. Five months have passed since the United States and Israel began bombing Iran. Oil prices have been highly volatile since the conflict began, and conditions could change quickly.
The effect on fuel prices and headline inflation has been smaller than initially feared, but Bullock noted that business confidence in Australia fell sharply at the start of the conflict. It's rebounded somewhat over recent months.
She said Australia's economy was more resilient than in the past because of the adoption of a credible inflation target by the RBA in the 1990s and because the economy had become less dependent on oil than it was in the 1970s. A given increase in oil prices still had a less direct and less pervasive effect on inflation today than it would have in the 1970s.
With inflation and capacity pressures already elevated, recent shocks had added further to the inflation impulse. That's why the bank tightened monetary policy earlier this year and remained focused on returning inflation sustainably to target.
Why This Matters:
The Reserve Bank's willingness to raise rates further underscores the challenge facing Australia's economy: bringing inflation under control without crushing growth. But the real constraint isn't monetary policy. It's productivity. Without productivity improvements, the economy can't grow without triggering inflation, which means workers won't see meaningful real wage gains no matter what the RBA does. That's a policy failure monetary tools can't fix. The housing market's unexpected weakness and rising unemployment show the real costs of letting inflation get away from the central bank in the first place. Higher rates were necessary because earlier policy allowed price pressures to build. Now households and businesses are paying the price through reduced spending power and tighter labour markets. The geopolitical shocks from Middle East conflict add another layer of uncertainty that markets and families can't plan around, making the case for keeping inflation expectations firmly anchored all the more critical.