Short-term pain for long-term gain: RBA

·3-min read

Another interest rate hike is all but locked in, but the Reserve Bank of Australia has not ruled out a slower pace of tightening.

RBA governor Philip Lowe said the 2.35 per cent cash rate was "still on the low side" but suggested between 2.5 and 3.5 per cent as a "neutral" cash rate range.

"We're closer to a normal setting now, which means that the case for large adjustments in interest rates is diminished," Dr Lowe told a House of Representatives economics committee on Friday.

At the next rate decision in October, he said the board would likely be choosing between a 25 basis point increase or 50 basis points.

Since May, the RBA has lifted its cash rate target from 0.1 per cent to 2.35 per cent in an effort to tame inflation, which has added more than $600 a month to the average mortgage holder's monthly repayments.

Informing these decisions will be the state of the global economy, how wages and prices are adjusting to inflationary pressures and household spending habits.

Dr Lowe said wages would have to remain subdued to avoid a wage-price cycle in which high inflation leads to higher wages that subsequently drive inflation higher.

"This type of cycle would lead to higher interest rates, a weaker economy and higher unemployment," he said.

He also said the central bank was relying on rising interest rates to slow growth and put downward pressure on profits, and warned businesses not to take home oversized profits.

"Businesses do have a role in avoiding these damaging outcomes by not using the higher inflation as a cover for an increase in their profit margins."

Dr Lowe acknowledged wages growth falling behind inflation and modest profit margins were painful, but said the short-term discomfort was necessary.

"So this year, wage growth is much less than the inflationary and that's really tough for people.

"But if we if we hold together on these two things ... next year we can look forward to growth in real wages again."

The alternative, he said, was letting inflation spiral out of control.

The RBA governor also commented on the role of fiscal policy to help support the economy.

While he had no particular concerns about the October federal budget, he said the government should consider tax reform and other structural changes "so the pie is bigger".

"The community wants all these things from our governments, which is understandable," he said.

"What we haven't worked out as a community is how to pay for it, and this is why we've got these budget deficits despite full employment and the record terms of trade."

In an opening speech, Dr Lowe defended the bank's earlier commitment to low interest rates until 2024.

"I'm frequently reminded that many people interpreted our previous communication as a promise or as a commitment that interest rates would not increase until 2024 - this was despite our statements on interest rates always being conditional on the state of the economy," he said.

In some concluding remarks, he said the bank would stick with its formula for future cash rate decisions.

"Good decision-making is a continuation of putting these various factors together and trying to make what I'd say are very difficult decisions that affect people unequally, and we know are making some people very unhappy," he said.