Transcript of Speech and Q&A Session Opening address at Banking 2022 Conference
Philip Lowe
Good morning, everyone and thank you very much for that introduction. I'd like to echo your comments, at how good it is for everyone to be back together again. This conference had been postponed a couple of times earlier because of COVID, so it's really good to be able to be back in a room with people and let's hope the health situation allows that to continue.
The ABA has set a challenging theme for this conference; that's planning for the future. The events of the past couple of years, and particularly the events of the past couple of weeks, served as a very good reminder of how hard it is to know what the future brings. But we can be sure that tomorrow will arrive, and we can be sure we need to plan for it. So I think it's an appropriate but challenging theme the ABA has set for this conference.
This morning, I'd like to talk about three issues on which I think we all need to plan. The first is higher interest rates. The second is a change in the nature of money. And the third is climate change and a restructuring of our energy system. All incredibly important issues and all ones that we need to plan for.
Before I talk about those three issues, though, I want to remind you about the resilience of the Australian economy. It's important because having a resilient economy gives us a really strong base on which to plan for the future. We saw this resilience in the December quarter national accounts. There was a very strong bounce back in GDP following the Delta contractions mid-year. The level of GDP in Australia is now 3.5 per cent above its pre-COVID level. No other major advanced economy is in that position. I'm expecting the economy to grow by more than 4 per cent this year, and return to something quite close to trends next year. So, of the advanced major economies, we're in a better position than any other. It's important that we remember that and it should give us confidence about the future.
The resilience is also evident in the labour market. This time last year we thought the unemployment rate in Australia right now would be 6 per cent. It's been 4.2 per cent for the past couple of months. There's an extraordinary number of job vacancies at the moment, and job ads are very high, so we're expecting the unemployment rate to fall further over the course of this year. And later this year, we expect at the moment that the unemployment rate will fall below 4 per cent and will stay below 4 per cent next year.
If that's what happens, it will be the first time since the early 1970s that Australia has had an unemployment rate below 4 per cent. It will be a very significant achievement and it speaks to the effectiveness of a combination of monetary and fiscal support. Together monetary and fiscal policy have worked and they've worked very effectively. It's really remarkable that two years into a global pandemic, Australia's on the cusp of the lowest unemployment rate in generations. Who would've thought that would've happened? In the middle of 2020 people were saying the unemployment rate in Australia could be 15, 20 per cent, and that there'd be deep and protracted scarring of our labour market as people lost jobs and opportunity, they wouldn't recover. Yet here we are on the cusp of the lowest unemployment rate in generations.
The resilience is also evident in household balance sheets. Households have built up a lot of extra savings during the pandemic. Most of us couldn't spend as we used to spend, and the government gave people money to compensate for their loss of income. So people had their income maintained and they couldn't spend, savings went up. So there's almost $250 billion of additional savings over the past couple of years. That's a huge amount of money. The median borrower now is two years ahead of their mortgage payments. Four or five years ago, the median borrower was one year ahead of their mortgage payments. So that's a big shift from one year to two years in just a short period of time. We're also seeing at the moment that loan arrears rates are coming down; they're fairly low and they're becoming lower. And many households have been able to pay down their credit card debt.
The banks supported their borrowers and their customers during the dark days of the pandemic and most borrowers are now back on track. Obviously not everyone has a big buffer and some people are still in difficulty, but most borrowers are in a better position than they were two years ago.
So you put together the resilience of the economy, the resilience of the labour market, the stronger balance sheets of households and the strong balance sheets of Australian banks, and I think we can have some confidence that we're planning for the future with a strong base, and we can look forward to reasonably strong growth over the course of this year.
So that's the backdrop. I'd now like to talk to the first of the three issues we need to plan for and that's higher interest rates. The last time the RBA increased the cash rate was in November, 2010. That's more than 11 years ago. So there are a lot of borrowers, and I'd say frontline lenders as well, who have not had any experience at all of a rising interest rates cycle. For many borrowers, that's going to come as quite an unwelcome development. Although I know from the letters that I get every day when I turn up at work, that many depositors have a different view and there will be part of the community that will welcome higher interest rates. So we've got to remember that as well.
The Reserve Bank Board have said they will not increase the cash rate until inflation is sustainably in the 2 to 3 per cent range. We're not yet at that point. Headline inflation is 3.5 per cent so that's higher than it has been for some time, but underlying inflation is just 2.6 per cent. That's just above the midpoint of the 2 to 3 per cent target range. That's the first time in seven years we've been above the midpoint of the target range. So we still have modest inflation here and we're only at 2.6 per cent on the back of really unprecedented disruptions in global supply chains, which have pushed up the prices of many goods. It's also relevant that aggregate wages growth is still running around a 2¼ to 2½ per cent mark. That's where it was before the pandemic, and before the pandemic, that type of wage growth was delivering inflation consistently below 2 per cent.
So wage growth is still modest and some of the increase in prices that we've seen is from supply chain disruptions that we would expect to reverse over time. So we're not yet at the point where we can conclude that inflation is sustainably in the 2 to 3 per cent range, but recent developments have moved us closer to that point. Inflation's been higher than we're expecting, the global supply chains are proving more contracted and taking longer to resolve than was widely thought likely. And in the last couple of weeks, the Russian invasion of Ukraine is pushing up commodity prices right across the board – high prices for energy, for all the base metals and for many agricultural products as well.
So given these developments, it is plausible that interest rates will increase this year. It's not guaranteed, but it's plausible. Two issues that we're watching very carefully here are the persistence of the supply side problems and the higher pressures coming from developments in Ukraine. So that's one issue. And the other issue is developments in domestic labour markets. On the supply side before Ukraine, there were signs that the supply side problems were starting to be resolved. Wait times for deliveries were starting to come down. The price of computer chips in global markets was coming down. So, there were still problems, but there were gradually being resolved and the resolution of those problems was giving our central bank and other central banks some confidence that inflation would come down. But now we've added another major supply shock. We had a big supply shock because of COVID and now we've got another one because of Ukraine. Inevitably, that's going to keep CPI inflation in Australia higher than it otherwise it would be, and it's going to be higher right around the world.
One issue that we're paying close attention to here is the inflation psychology. For many years, firms were reluctant to put up their prices and because they didn't want to put up their prices, they didn't want to put up wages. It's quite possible that a period of protracted headline inflation will see this psychology shift and firms will decide that they have to put up their prices, and if their prices are rising, then they can afford to pay higher wages. So we're watching very carefully for any shift in the inflation psychology. If that shift were to occur, inflation would be higher and it would be more persistent and we would need to respond to that in time.
The second issue is domestic labour costs. We expect wages growth to pick up, but to do so only gradually. And the gradual nature of the pick-up reflects some institutional features of our labour market: the fact that we have multi-year enterprise agreements that often don't get negotiated for three years; we have an annual review of award wages; and there are public sector wage policies that cover a lot of labour force and they change only slowly.
So a pickup is clearly taking place, but I think it'll be quite some time before wage growth picks up substantially.
There are a couple of uncertainties here, though. We haven't had any experience where I said for 50 years for unemployment below 4 per cent, so we can't be sure how wages respond to very low unemployment. And we can't be sure about the inflation psychology. If that shifts then understandably workers would want bigger compensation for higher inflation and firms might be prepared to pay a higher wage. So they're the issues that we're watching on inflation. The message here is it would be prudent to plan for an increase.
The second issue I wanted to talk about where we need to plan for the future is a change in the nature of money. If you look back through the long sweep of history, then what societies use as money is influenced by the technology they have. Some societies used clamshells a long time ago. For a while societies were using silver and gold coins. Right here in New South Wales, not many streets away from here in the colony of New South Wales people used rum. That was the best technology they had at the time.
Then we moved onto paper banknotes, and here in Australia you have these wonderful polymer banknotes with sophisticated holograms in them. The most common form of money today is electronic bank deposits that we can move over the internet in seconds thanks to the bank's' investment in the NPP. So what constitutes money in society changes over time. I think it would be foolish to think that this innovation and the nature of money is finished. There will surely be more innovation. We can't be sure what the next innovation will be, but I think there's a fair chance that it'll be some form of digital token sitting in a digital wallet or a digital device.
There are really big issues to think through here from both the technology perspective and from a public policy perspective. On the technology side, relevant questions are what form will these tokens take? Will they reside on a distributed ledger or some other form of technology we use? How do we ensure that the system is resilient and that it's not subject to some form of counterfeiting? Just as we spend a lot of resources making sure that banknotes can't be counterfeited, we need to make sure these tokens were secure. Would these tokens be anonymous and private like banknotes so they can move around without leaving a fingerprint or would they be traceable? And under what circumstances would they be traceable?
So there are a lot of technology issues here that need to be resolved and from a public policy perspective, there are equally challenging questions. These include, should the tokens be backed by the central bank? Just as we back and issue banknotes today, we could back and issue these tokens. If instead a private entity was to issue the tokens, how do we ensure that they're interoperable between various issuers and what are the collateral arrangements that would back those tokens? Another issue the central banks are considering is should these tokens pay interest? If we did, that could change the very nature of the financial system. People might prefer a central bank token that pays interest to a deposit at a commercial bank and if they did, that could reshape how financial intermediation works. So it's a big question.
Another big question is what is the potential for these tokens to destabilise the financial system, particularly in periods of stress? You could imagine in a difficult period that people decide they want tokens back by the central bank rather than deposits in a commercial bank that was under stress, and it could be quite easy to run from bank deposits to these tokens and it could destabilise the bank system. It would make bank runs easier. So if you're worried about that, how would we mitigate that risk?
So they're the public policy issues that the Reserve Bank is working through together with our international colleagues. They're important issues, but we need to prepare for them because, as I said, the nature of money changes with technology and technology is changing quickly.
Given this, the Reserve Bank very much welcomes the government's response to a thorough review of the payment system. The first important step here is the development of a national payments plan. And I would encourage you all to be as actively engaged in that process as you possibly can. We need that plan and it needs to be good and it needs wide buy-in.
There are also important pieces of legislation that will need to be passed to make sure that Australia is well placed for the innovations of the future. This legislation includes the modernisation of the Payments System Regulation Act, which governs with the payments system board of the Reserve Bank can do. That legislation was really leading edge when it was developed more than 20 years ago, but it's outdated now.
We need legislation to give effect to a new regulatory regime for stored value instruments, including stable coins and what the collateral backing for those coins should be. We need legislation to set up a tiered licensing regime for payment service providers. We need legislation for the regulation of crypto-assets, including the custody arrangements for those crypto-assets. So there's a lot of work to be done here by both parliament and by people in this room. They're important questions – we need to get them right. It's clear the digital economy is integral to our future and we need a payment system and a banking system that can serve that digital economy efficiently, effectively, and safely.
The third issue that I want to talk about that we need to plan for is climate change. It's obviously a first order issue for the financial system. We were reminded of it as we walked into this hotel this morning. It's also an issue that comes up in every single conversation I have with foreign investors. They want to know how Australia is going to make the transition to a less carbon intensive economy. They want to know what Australia's plans are. They want to know what the opportunities are that Australia has, and they want to talk about the risks that we have as well. So we need a plan here. We need good answers to these questions, and we need to plan for this transition.
The financial sector has a really important role to play here. Australia has great opportunities and it served as a reminder, my Deputy resigned yesterday to participate in those opportunities. Those opportunities take financing and people in this room play a critical role in helping provide that financing. And there are risks here as well, and people in this room will help us manage those risks.
But you can only provide the financing and manage the risks, if people are able to price, measure and manage risk. To price, manage and measure risk, you need information. So from a regulatory perspective, the members of the Council of Financial Regulators are working on a framework to help establish that information. So one of the things we're working on is the Climate Vulnerability Assessment that APRA is leading. We want to help financial institutions identify and understand the risks they face. Whether they're credit risks from stranded assets or change business models, or they're insurance risks that are building or risks coming from the repricing of assets in capital markets.
So that's one important thing we are doing. Another is helping improve disclosure requirements. In this area we need disclosure that's clear, that's comparable across countries and that's comparable across companies. Without having really good disclosure in this space, investors, banks, and capital markets, won't be able to do what they're really set up to do, and that is allocate capital. So people need the information and that information needs to be quality and comparable.
Unfortunately, we're not yet at a point where there's a widely used and accepted international framework for these disclosures, although members of the Council of Financial Regulators are working on this with their international counterparts to try and make progress here. I think the main message here is that in planning for the future, we need to provide the people who want to make capital decisions with information, and it needs to be quality information. And if we can do that, then I think institutions in this room can help Australia seize the fantastic opportunities we have in this area. So that's a huge challenge for the future.
So the issues that I've talked about today – higher interest rates, the changing nature of money and climate change – are only three of the many issues that you need to plan around and then some of these other issues are on the table today. I could have added to this list of three, three more. The need to plan how best to take advantage of the new technologies that are out there. Not just the changing nature of money, but the way banks are run and the way they organise themselves. A second would be the need to plan for strong cyber resilience. As anyone who's involved in cyber resilience knows, this is a challenging area and the bar keeps raising and we need to keep moving with it. And the third challenge we all have is the need to plan for a tight labour market and to invest in the skills of our people.
One of the things the Reserve Bank has been trying to do, is get the unemployment rate down and we've been successful in that. But it creates new challenges for us all and I think we need to work on how to attract, retain, and invest in our people in a tight labour market. That's another challenge. So Ticky, you have plenty to talk about today and I'd be happy to answer some of your questions. Thank you.
Question & Answer Session
Ticky Fullerton
Well, Governor, thank you very much for that speech and indeed, for taking questions from me. Before we get to policy, let's go to the loss of your 2IC, Guy Debelle. You were told, I think on Thursday night. He was in the box seat to be Governor. Had you any inkling at all?
Philip Lowe
No. I found out earlier this week. It came as a surprise to me. We've worked very closely on issues over 25 years and I was as shocked as everybody else.
Ticky Fullerton
So, Guy Debelle was only recently reappointed as Deputy Governor for another term. What was his explanation for the decision to leave?
Philip Lowe
Well, he's probably better off answering that question. He says that he's long had this interest in climate change and another very strong interest is in capital markets. So the new position allows him to bring those two things together. Climate change and capital markets, and he's made an outstanding contribution to the Reserve Bank over the 25 years he's been here and that has helped the country as well. And he feels now that he can help the country in another way, to use his expertise in capital markets and his interest in climate change to help this transition to a new set of industries, which could be the source of our comparative advantage in the future. So he feels like he can contribute to the welfare of the Australian people, which is the third objective of the Reserve Bank, in a different way. So, I commend him for that. It's a huge loss for me and for our institution, but I can understand why he feels he can make a contribution to society in a different way now.
Ticky Fullerton
Well, yes, good on him. But as of Wednesday, you lose your sounding board who you worked with, as you say, very closely through the pandemic, the ideas, the thinking on policy. He's been described as adding credibility to Andrew Forrest, FFI, but he leaves you just at a time when you've got this tension between the RBA and market economists and others, over how soon to raise interest rates. And this week former treasurer, Peter Costello said, 'You need to get with the curve.' You're going to miss him, aren't you?
Philip Lowe
I will miss him. I'm not running away from that. I will miss him. But we do have a deep team at the Reserve Bank. There's a deep reservoir of expertise. So we've got a lot of colleagues and the way that the Reserve Bank is run is a very collegiate and team-based thing. So there's a very strong team there and all the decisions we take are collective decisions. And there's a team that supports that process.
Ticky Fullerton
And how you deal, and your team deal with this mounting pressure? Because it is mounting pressure on you, over a rate rise, isn't it?
Philip Lowe
I don't feel mounting pressure. In each day we sit there and think, 'Well, what's the right thing to do'. We have the Reserve Bank Board meeting once a month, we sit down, we review the information, discuss, 'Well, what's the right thing to do'. And when we're having those discussions, we put aside all that external noise because we know people always have views, and we respect those views and we talk about them, but we do what we think is the right thing at each of our meetings. So the pressure, it's great for media stories, but I don't feel that myself.
Ticky Fullerton
Now, the Treasurer will appoint a replacement in due course. Is there a strong internal candidate?
Philip Lowe
There are multiple strong internal candidates. So it'll be up to the Treasurer whether he wants to choose one of them or he wants to choose someone outside the Bank.
Ticky Fullerton
And is that likely to happen before caretaker?
Philip Lowe
I don't know. I would hope so, but the government will have to go through a process. It's a really important position, so they want to make sure that they pick the best person and they'll have to go through their processes. If there's an opportunity to do it before the caretaker provisions kick in, I would welcome that, but if they need to take longer, they'll need to take longer.
Ticky Fullerton
So Governor just on inflation, you now say in your speeches, not in the Q&A, which I think is a significant move this week, you talk about this, the idea that this is plausible, that there will be a cash rate rise this year. Not guaranteed you say today, but plausible. Now part of this is about the pile on with Ukraine and the energy crisis. The energy people are saying with gas market in particular, this is a structural change. Corporates are pulling out of major projects. Why don't you appear to think that this is a structural change?
Philip Lowe
It probably is a structural change and what that will do, will increase the level of gas prices, and when the level moves up, there's inflation while that's happening. But once you're up to the higher level, the prices don't keep rising, do they? So I think what we are seeing at the moment is a whole bunch of prices go up and in level terms.
Ticky Fullerton
But isn't that structural change enough to keep inflation sustainably higher?
Philip Lowe
It will depend upon what happens to the inflation psychology because during the period in which this shift in the level of prices is occurring, we record higher inflation. But if the levels don't keep rising, then that will wash through the numbers and inflation will come back down. And whether it comes back down really depends upon what happens in the labour markets. If a period of high inflation – I think we're going to see CPI inflation numbers with a four in front of them – if that leads to a big shift in wage demands and those wage demands are successful, then we could see persistently higher inflation that would have implications for interest rates. But it's entirely possible that this level shift occurs, we have higher inflation for a while and if wages don't move too much, then we come back down again. That would still be my central scenario that this will wash through. But as the developments in Ukraine keep occurring, then there's going to be more to wash through and how long can that take place without the inflation psychology shifting. That's the issue that we are discussing every single board meeting now.
Ticky Fullerton
So just on wages growth, you mentioned 2¼, 2½, modest at the moment, but what's your sense of where wages growth is going? Because that was sort of still lockdown numbers. Are you expecting a jump in the next figure?
Philip Lowe
A jump … I'm expecting an increase and a steady gradual increase. Most of the people in this room probably know of people who are getting very big wage rises. In professional services, in legal services, in IT, IT security, banking, risk management, compliance, people are getting big pay rises. Most of the people in this room working in that world, but we've got to remember that most Australians don't work in that world. Most Australians work in a world where their pay rises are two point something, and it teaches people in retail and most people in hospitality, in the public sector. So the lived experience of most Australians is a wage increase starting with two. When we talk to businesses every month, and we normally do 100 to 150 interviews a month, and we ask what the wage increases are like in their business in the next year, the number is staying two to three. Of course, that could change if inflation psychology changed but I think people in our profession have got to be careful not to translate what's going on in our profession to what's going on out there in the lived experience of most Australians, and most Australians are certainly getting wage increases of two-point-something. I hope that will turn into three-point-something but it's going to take time.
Ticky Fullerton
Alright, I'd like to put to you a scenario that CBA chief economist Stephen Halmarick put this week. Credit card data spending was strong February into March, CBA. He said CBA sees December quarter CPI for the end of March, the headline rate will be 4 per cent or above, the underlying 3½. In the middle of May when we get the next wages number, he thinks that will show acceleration. So by June, he says the RBA will be ready to hike. By then New Zealand, Canada, the UK and the US will have hiked now. Is that plausible?
Philip Lowe
He seems to have a better crystal ball than I do.
Ticky Fullerton
But is it plausible? A June hike.
Philip Lowe
Yeah. I mean the whole range of scenarios and I said before every single meeting we sit down, we look at the data and we make what we think is the best decision. There are plausible scenarios still where the rate rises don't occur for a long time, well into next year, even further, so …
Ticky Fullerton
But as early as June is plausible?
Philip Lowe
I don't want to put a particular month on it, but we will look at every month and the data we have. So, presumably if there's a certain configuration of events that could lead to an earlier increase, but it's also plausible that this gets pushed out again further. It's very hard to predict what's going to happen. I heard Stephen. I wish I had his crystal ball.
Ticky Fullerton
Yes. Governor your term finishes 2023. Will you extend and has Guy Debelle's departure changed your thinking at all on that?
Philip Lowe
It hasn't changed my thinking. The job that I have, it's a huge privilege and honour to have it and whether I stay on beyond the current term is really a matter for the government. It's a privileged job, but it's also a job of public service. I feel very strongly about public service, so I would do whatever I was asked to do.
Ticky Fullerton
Can I ask one final question, which is that central banks around the world worked very closely during the GFC with each other. Now that was a scenario about lowering interest rates obviously. I'd really like to know how much you are all in contact as a result of the events in Ukraine or in terms of some sort of coordinated move or agenda. Or is the fact that Australia and Japan's inflation situation is so different from the US and the UK means that's not really happening.
Philip Lowe
I chair at the Bank for International Settlements the committee on the Global Financial System. We had a meeting last week, and the developments in Ukraine were clearly the issue that we were talking about. And tonight, Friday night at 11.00 pm until 1:30 Saturday morning, I'm speaking with the governors of all the central banks. We've got a regular scheduled meeting tonight. So you can imagine what the topic will be on tonight's discussion, but the idea that there's some coordinated policy response we don't really talk in those terms.
Ticky Fullerton
But there was during the GFC.
Philip Lowe
There was and that was largely because financial markets had frozen and the central banks needed to unfreeze those financial markets. At the moment, I don't think there's a need for a coordinated policy response. What there is a need for us to do is to sit down and share information and talk about where things might go from here and we'll do that tonight.
Ticky Fullerton
So presumably a big part of that is sanctions and the impact that that's happening having on the global system.
Philip Lowe
Yes, and the assessment has been in the first couple of weeks, it hasn't caused major dislocation in the financial systems. It's causing dislocation in Russia, but not in the global financial systems, but it's still early days. There's a lot to come for these sanctions to work their way through the financial sector and we'll look at that again tonight.
Ticky Fullerton
Yes. Governor, it's been a very big week for you, I know. Thank you again very much for taking my questions.