RBA Deputy's inflation warning

[Music] From the conversation, this is Politics with Michelle Grappen. [Music] The Middle East conflict has thrown a curved ball into the Reserve Bank's consideration of interest rates at its meeting next week and the government's preparation of the May 12 budget. The conflict is pushing up oil prices as supplies disrupted and bringing major uncertainty for the international economy and for the Australian economy. Reserve Bank Governor Michelle Bullock has flagged next week's bank meeting will be quote "live" unquote signaling the could be a change in rates. Today we talk to Andrew Halzer, deputy governor of the bank who has just returned from New York where he attended a forum on monetary policy. Andrew Halzer, can we start with the assessment being made for the prospects for the price and supply of oil? What's the best current information? Well, it's usually thought that the best current information is in the price but the price of oil on global markets has been extraordinary volatilus as you know Michelle. Brent Crew, one of the the standard bank shlarts, was $70 a barrel before the attack at the end of February. It reached a high of $117 a day but it's currently fallen back to about 90. I've got my screen open and perhaps we should come back at the end of the podcast for an update. What's driving that volatility? Look, I think you know there's the key concern is the impact of the threat and closure at the state of Harmouz from Iran. 20% of oil production goes through that and the potential for the gold stage having to throttle oil output particularly with their storage also being attacked. You know, it's just to be pretty significant. The promises the President Trump made on insurance and support for shipping and the straight. I think we're treason with a degree of skepticism by some in the market and the sense that the war could drag on for a very long time as the war countries were drawn in and the uncertainty over the regime change in Iran have all led to you know those bigs up and those big downs. As you know the fall today and overnight came from two things the statement by the G7 that they were looking to release their strategic reserves and President Trump saying that the war was very complete to use his language. I think the reality is that this is all in real time at the moment. It's a global price. We're all facing the same volatility. We're all roaching the same screens but so far we are up materially on before the conflict but nothing like as large as we were yesterday. Well you'll be doing some numbers obviously ahead of next week so bank meeting. How does the BIA begin to assess the impact of these prices given the volatility? Yeah I mean it's a genuine challenge on the upside. We did exercise last year, the middle of last year, when it looked like conflict between Israel and Iran was going to pick up and so we do have a framework. The first point I think I'd make is an obvious one that it does depend on the size and the persistence of the price shock itself and as we just discuss you know that's very uncertain so we need to keep our assessment updated in real time and we also need to work on the basis of scenarios what is. In terms of the channels on inflation for Australia you have the immediate effects on the cost of petrol or the pumps everyone's seeing that in real time today of course over time you that pick up in the cost of fuel will push up on prices and cost for firms and it has implications over the longer term for people's expectations about wages and prices so there's a few channels there. On activity well this is a classic adverse supply shock to use the jargon which means that higher cost for firms is likely to reduce their output but it also weakens demand lower consumption spending the impact of uncertainty on household and companies tighter financial conditions and that's not just in Australia but so the seas as well to demand our outputs so you know you have a couple of offsetting factors there but there is one another important point to mention and that is although Australia is a big oil importer we're in net exporter of energy and if you assume that the oil price is well correlated with the price of gas and other outputs that we export there will be some positive demand effect for Australian exporters that have offset some of those effects on activity. The final channel you know said that this was long enough is the Australian dollar obviously the Aussie dollars often thought of this was sort of a classic yeah risk on currency and this is a risk off move and actually Australian dollar obviously picked up a little bit over the past week or so it's relatively stable in the past 24 hours but that can also affect inflation so a lot of channels to think through and the team here is hard at work crunching through those numbers. Well particularly on inflation the National Australia Bank has predicted that inflation which is now at an annual 3.8% could be 5% by mid-year is this in line with the bank's current assessment and how alarming is that sort of prediction or forecast. I think it's worth remembering the economic backdrop that we face here the Australian economy in many ways is in good shape growth is recovered quite maturely over the past year unemployment is close to historic lows and compares very favourably internationally and average levels of wealth and income in the economy are pretty good by international comparisons that you know we have a problem with inflation it's too high the latest age as you say headline inflation in general is 3.8 underlying 3.4% on a year earlier and our projection is that inflation will only return to the target range by the end of this year or internet year and only back to the midpoint of that target range in 2028 and that's before this oil shock and other events. That was all before this oil shock in February. I should say Sally Alders the Chief Congress of NAB and I have a lot of time for Sally actually she's very thoughtful economist I think she spotted that that projection as we discussed that preceded Iran had a peak of headline inflation already at 4.2% in the middle of 2026 so that was the base she was working on. I know the 5% number is grabbed headlines but when I went and looked at her pieces in fact very thoughtful she's worked through many different scenarios for the possibility of oil prices. It's a current oil price in global markets around the sort of mid 80 dollars. I'm not sure actually that her scenario is for inflation I get quite as high as that 5% number that 5% I think assumes that the oil price is in the sort of 100 dollar range which we're well into yesterday but not into today. We don't have updated numbers on our forecast now we don't actually formally update our forecast until May which is the meeting after the one coming up but it clearly is the case that it's an upside risk to that projection in February it's still in flux there are a number of offsetting factors for us to crunch through so we have a whole army of our economists at the moment working through that I don't want to give a number that might give a full sense of accuracy the certainly directionally is higher than the projection we published in February. But are you saying that this 5% which is you say has grabbed the headlines that's a big pessimistic without being more precise than that. Well if you if you recall is those analysis I think the 5% number assumes the level of oil prices in international markets is a little bit higher than today but as we said with the outset of the interview Michelle you know this number could be back there before we finish talking so it all depends on where that oil price goes I think it probably looks a little of the pessimistic side compared with where we are today but who knows where we'll be by the time the board meets next week. Now Governor Bullock has said that next week's meeting will be live which means the could be a rate change does the Middle East conflict with its impact on oil prices and a whole lot of other effects make more or less likely a rise in rates in the near term. Well let's just say this is going to be a lot for the board to discuss next week I say I mentioned a minute ago you know our projection in February before the Iran attacks was for inflation only to return to the midpoint of the target on the assumption the technical assumption that the cash rate did pick up a little bit further from where it is now so the question is how the data since then both in the domestic economy and on Iran changed that picture there's clearly information on the upside for inflation over that period we've had some data that seem to have confirmed even more decisive than we have before that our economy currently has limited spare capacity unemployment came in a bit below expectations job avatars and other measures that demand for labor was a little higher GUP growth came in at 2.6 percent on a year early which is great news of course but it's rather bigger than our 2% estimate of the capacity of the sustainable rate of growth in the economy inflation was in line in January with our expectations so those are the whole load of news but as we've already discussed that's all above our top target range. So again, it's that backdrop, you know, he's fair to say, you know, further increases the prices from Iran, is that is what we end up seeing? And that is the big if it is not a helpful development from the perspective of our policy discussion. That said, there are arguments to discuss on the other side as well. I think I too in particular, the first, as we've, you know, already discussed half a dozen times on this call, is the uncertainty over development in Iran is extremely high. That will, if it persists, press down on global activity. And that's a downside effect to refer into the mix. The other point is, you know, if you look at the domestic data carefully, not everything came in as strongly as expected, consumption growth in the last quarter of last year was a bit weaker and unit labor cost, which is something that we look at closely fell back a little bit further than we've been expecting. So there are arguments on both sides. I'm sorry, that's a sort of a bit of an eye to roar argument, we're sure, I know you're just telling us like this very much. But I think there'll be a very genuine debate. The situation is too high. Higher prices don't help that debate, but there are arguments on both sides. And I think if ever there was a time when board members will learn their media salary, it'll be just once. Well, obviously things are likely to be just as uncertain next week as they are as we speak this week. So in those circumstances, how difficult is it for the board to make a decision on rates? And what's the danger of not making a decision? It does seem to me the more you speak. It's in each way bad, but on the other hand, a decision has to be made. There are three choices. You go up, you go down, you sit on your hands, and it's dangerous wherever you land, surely. Well, I was always thought long ago not to complain about the difficulty of our job as central bankers, where we have an important and serious job to make, but if you all see a difficult job, you know, go look at firefighters, go look at nurses, say, in all seriousness, we approach these decisions seriously every month, but I don't want to, I don't want to make it seem that somehow we're paralyzed by that fact. We're always balancing risks. There's never an obvious answer for policy, whatever you might read in the press, it's set to an arrears, perhaps when there is terribly easy to know what policy should have done a year ago. It's not always easy to know in real time. We've got important data to process as we discuss. And I think there are risks on both sides. If we fail to act discosively enough to prevent inflation saying high or even rising and expectations of inflation disanquer, as they have not today in a long term sense, but if we do see that disantering, it will be bad for everyone and it's worth us continuously reminding ourselves just how toxic inflation is. We've only just had an experience in that and we don't want to go through that period again. So failing to raise rates to the the level they need to be and allowing inflation to get out of control is a clear problem. However, there are risks, as you say, on the other side as well. If you act precipitously, if you compound uncertainty, if you drive the economy to slow down too rapidly, then you are going to push inflation down and you're going to harm people, a sudden employment picks up. To be frank, we're always balancing those two alternative risks. I think you're right to say the scale of both the upside and potentially the downside risk for us this month is probably rather larger than normal. Looking further down the track, I think what homeowners want to know, or those paying mortgages want to know, is what can we expect in the next say year in terms of movements in interest rates? Well, look, if we do need to get in trouble, if the finance was a bit dangerous to say this, what I do hope we'll be able to show is that we have brought inflation back down into or close to the target range, that employment has remained close to full employment and growth has held up. I will be very happy indeed if we manage to get those macroeconomic outcomes. That's the mandate we've been asked to deliver by the Australian people and we're all very committed to delivering it. I'm afraid to say that what path of interest rates is required to get us to that outcome is less certain. It's always less certain than the outcomes we're targeting and it's probably a bit less certain still against the backdrop of the developments that we've been discussing. To be honest with you, I'd be lying if I told you otherwise. What I hope we will be able to say is that we have delivered on our macroeconomic mandate and that interest rates are on a sensible path back to normality, but whether we're able to say that or not any time will tell. Well, indeed over the years, the bank has often missed its target on inflation. Do you think this has lessened the bank's credibility with the public and raised the risk of a blow out in inflation expectations? I went back and looked at actually the average inflation out-turns since inflation targeting came in. It's a bit of a debate that you've been wearing, but let's call it 1992, which I think is when Bernie Fraser gave a speech on the subject. The average inflation rate over that long period of time is actually 2.6 percent. In other words, give or take a tiny amount bang on that midpoint to the 2 to 3 percent target range. I mean, give you take a very long view. I will honestly come back to your question in a minute. The presumption that the bankers on average missed its target is that were to be a suggestion. Isn't quite right. I think maybe that's one reason why long-term inflation expectations actually are still well anchored in the middle of that target range. You might ask, well, how on earth do you come up with an envelope like that if you put the book saying, I don't think to have, but it reflects the fact, as you all know, Ben and me Michelle, that there was a long career before COVID, when in fact inflation was coming in too low and not as it currently is too high. There's two periods somewhat average out, but look, you can never take the credibility of what we're here asked to do for granted. That's why it's so important, actually, that we do take the steps needed to bring inflation back to target from its too high level at the moment. I don't think people should be on any doubt about our commitment to do that. If we deliver on that, I hope people will continue to expect, as they appear to at the moment, that the inflation target will be hit in the long run. While the Middle East war is making the bank's tasks much more difficult than usual, it's also causing the treasurer some traumas. It has though both positive and negative effects for the preparation of a budget, doesn't it? And I wonder if for our listeners, you can just walk us through those pluses and minuses. Yeah, it seems that an odd thing to say, doesn't it? That's such a serious war in such a key part of the world, potentially, has the silver lining. The important point here, I think there's back to the point I made it earlier on. We are as the country a net energy exporter. And therefore, when the demand for and therefore the price of those energy exports on average goes up, you know, national income at the margin at least in those terms may increase. It may decrease for other reasons, but it's so those sectors it may increase. And to the extent that the government is effective in living a value-based tax on those outputs, its income for those reasons alone will go up. I think our assessment is not necessarily a huge effect. The fuel-lexised tax, to understand it, is based on volumes rather than prices a petrol sold. And obviously, we only have a limited ability to diversify away from what we use. And natural gas receipts are the big export of ours, and not a huge share of total government receipts. But it may have a positive sign on it that effect. Far more important, though, for the fiscal accounts after the economy will be the outcomes for inflation and activity and employment. And as we've discussed, there are some challenges to all of those macro variables from the Iranian outcomes. So I'm sure as the especially countries through those numbers, they'll be working on a sort of balanced picture just as we are for monetary policy. More generally, you welcomed the growth figures of the other day. How are in broad terms as the Australian economy travelling compared with comparable economies? And especially how well is it travelling or how badly, if you like, in terms of productivity? Well, in many ways, Australia can be quite, quite proud of its economic achievements and the recent period. As I said, it grows just recovering. Unemployment is closely historic lows, and certainly very enviable by international comparisons. And wealth levels in the economy on average, of course, not at the lower end, compare very favourably with other countries, including, I should say, my own in the UK, I think Australia is about 25% more wealthy on average, per head, being united. Kingdom, that's a good baseline. But if you say productivity is not such a good story in Australia in recent years, The level of productivity still remains pretty close to where it was in the sort of mid 2010s, and that's a very unusually weak performance. Our assumption is that productivity growth only rises by about 0.7% a year in the next couple of years, which gives you a sustainable growth rate of about 2%. So that isn't spectacular by historical standards. Why are we in that situation? And what about other countries? Yes. And apart from the United States, where as you say I've just returned from, which is experiencing something of a productivity miracle for reasons largely related to the AI and tech boom, most developed countries are struggling with a very similar picture to Australia. We have seen a wave of growth in our recent past, but we are not seeing the same productive capacity strengths today. There's an enormous list of potential drivers that people smarter than me, the productivity commission, the Kroger and elsewhere, would list as drivers for that. And as you well know, the criteria and the government have said that there are three key priorities this year, a productivity inflation in the world economy is looking at that. That was a pretty good take on the three things that we're all going to be facing into this year. So we aren't looking good by historic comparisons, but we're not out of the pack for the most developed countries other than the United States. We need to do better. And I know that that's very much on the mind of government and of companies here as well. Do you think there's hope that AI will transform this situation or will it affect be lesser than that on productivity? Well, I mean, this is the fascinating question and we're not for a run. I think we probably be just spending a lot longer on this call talking about it of the many conversations I had in the US when I was out there, you know, fully 80 to 85% of them were dominated by discussions about AI. What was it going to do to employment in the US? How is it going to change the organization as companies? How is it going to drive productivity growth? What was it going to do to social cohesion? It's a very, very live debate in the US. I detect that we are not at the same level of advancement here on maturity or whatever the right word is without being rid of a high-docky country on that issue in Australia, but it is trifantly important for every negative story that you hear. There are some very strong positive stories as well about people co-working with AI to produce better products. One of the more interesting stories I heard from many in the US was not that they were being asked to deploy AI to cut their headcount, but they were being used to deploy AI to very aggressively boost their revenues. One company said that their CEO confidently expected them to double the size of their already very large company over the next five years with no increase in headcount at all. Who knows if that can be achieved, but I don't think it's all gloom in doing with AI, but it's a very important debate and it will come to Australia in due course as well. Do you think there's a lot of fear in Australia about AI? Does the fear outweigh the perceived benefits at least in ordinary people's minds? I think if you look at surveys of this question and Michelle, you're closer to it than me. The short answer to that is probably yes at the moment. I think it's right to be asking serious questions about what AI might mean for the privacy of our data, for our children, for the future nature of work. Those are sensible questions to be asking. We're asking them until I'm in the RBA as well as externally as well. But I think we can afford to think about ways in which those technologies can be deployed through our advantage as well. One of the things I never tire of saying about Australia is that it's an outsider to the country. When I look at the recent economic, when I say recent, I mean the last 50 to 100 years of Australia, Australia has time and again. It's done an incredible capacity to harness technologies and its natural, raw material strengths and its natural ingenuity and human capital to profit, frankly, or to benefit from challenges in the global economy. And secretly, I am more optimistic than many people I speak here that Australia might pull that off again. When you talk about us being behind on this AI question, are you talking about the deployment of the technology or are you talking about the general debate about the deployment of AI? I mean, the first, I think on the second Australia has in many things released the world on the richness, diversity and quality of the debate. It's one of the things I was told to expect when I came to this country about monetary policy and I think it's a great feature of the country. I think as we've discussed here already, I think it's a look forward to having a balanced discussion about the benefits it could give to a country whose history has been so strong in terms of harnessing new technologies, was being realistic and open also about the potential costs and risks that it poses to us. Just a return to the bank for a moment. The Reserve Bank is much more open than it used to be in terms of the economic debate, talking about what it does and this has especially been enhanced since the reforms that this government brought in. But it does have a downside and Michelle Bullock is repeatedly having to fend off questions about the level of government spending and dodged questions. In general, do you think this openness is a net benefit or does it risk the bank being drawn into the political debate and thus being politicised to a greater extent than has been the case previously? Well, I mean, I don't want to answer my own home voice. I should ask you and maybe your list is as well whether the great openness, which you're quite right to say we have tried to embrace in the last year or two, is the net benefit or not. I think certainly the finding of the RBA review was that being more open was, you know, came with a territory and was important to do and I should say I personally strongly agree with that. It's had duty, I believe, to speak, explain and importantly also listen on issues relevant to our job of delivering low and stable inflation and full unemployment and it's right that we're held to account by the crest, by the public, by parliament. You know, if necessary, robustly for our successes, but also where we don't deliver on those things. And I came to Australia looking forward to that part of the role and I hate to be frank with you is not just to have I tolerate it. I actually like being challenged and debating what we do well and what we don't. And hearing alternative views, that said, it's in fact, not the place in my view of unelected central bankers like me to stray from our lane and start giving free advice to governments on how to make decisions, political decisions about the allocation of national income across different priorities. I always say, you know, I grew up in Europe obviously, it's all in Europe where the ECB, European central bank, it's been years of his life giving advice to the national governments of Europe about how they should do fiscal policy. It had absolutely no effect and ultimately led arguably to the ECB taking its eye off its own for we had similar experiences in the UK. And for everyone who thinks, wouldn't it be great if an unelected official like me came in alongside them and said, why doesn't the government direct one said, I always say to them, what would you think if I, an equally unelected government official came in and took the opposite view? You'd say, how bloody dare you get involved with politics? You've been given a job to do. You haven't done it as well as you might have done it the past year, get back to your knitting. So I think we should be out there and about speaking about the things that we're asked to do. And personally, I don't find these criticisms that we're not giving free advice to government at all persuasive. So, yes, there's a risk of being drawn into the political craze, because if we stick to the discussions irrelevant to us, I don't see a downside to us being open. I want to ask you a question about a former colleague. You worked with the Canadian Prime Minister, Mark Carney, when he was governor of the Bank of England. And now, of course, he's making quite a splash internationally with his calls for the middle powers to step up. And he repeated that call when he was addressing the federal parliament last week. Just give us some personal impressions of him and are you surprised at where he's landed? Well, it was a great privilege to work with Mark at the Bank of England. He was a very different type of governor to his predecessor, and he's a successor. I tell you, what words would I use demanding, but inspirational? I think it would be two words I chose through some very big and important periods that we work together, including perhaps most importantly Brexit, which of course has all sorts of echoes with the kind of global trade issues that we're dealing with now. He always had his horizons on the world stage, even when he was at the Bank of England. So, frankly, it's those surprised to me to see him ending up as the Prime Minister of Canada. He was always very valued driven. You'll know that was the title of his book, I think, in 2021, believer in free trade, the role of markets. If he had a doubt, it was that sometimes those principles haven't been put into effect as clearly as they might. But he's also, and you see this more in private perhaps in public, very hard-headed, frankly about global politics and global economics. He was at Goldman Sachs for many years of the Canadian Ministry of Finance since the Bank of England at Brookfield Bloomberg, as strike the payment company. You know, you name it. He always saw, perhaps more than some of us, like you soft-hearted, career central bankers, you know, the realities that the global scene with very hard eyes. And I think, you know, since he left, has obviously led him to recognise that when times change, policies have to change, too, in countries like Canada and Australia, of course, who fundamentally rely on the health of the global economy, have to recognise those new realities. Not a tool surprise where he's ended up and that he is an important global voice. But let me end, I guess, on one note, that I think the vision that Mark is espousing perhaps this uniquely his is actually the one that Australia has been operating itself, for at least the last quarter century, the concepts of, you know, verbal geometry, focus on comparative advantages, minerals, energy, education, our openness to people in capital, our position of regional understanding and Asia-Pacific and so forth. Our thing is that, you know, Australia has always, or certainly in the last few decades, has certainly implemented with some skill and penational, as I say, has helped it to navigate the areas of global upheaval with real nimbleness and intelligence. And I personally have some seeking confidence that we can do so again. The RBA job is limited, but important in that project. And that's to strive to maintain low and stable inflation and full employment through this period of turbulence that we undoubtedly are in and may lie ahead. Just before we finish up, I want you to check that all price and see if it's moved in the last half hour. Well, perhaps fate is smiling on us and actually it looks relatively stable. It's down a little bit, $88 rent at the moment, per barrel, which is slightly down on that sort of 90ish number that I think we had a little while ago. But a blessed period of time against what I'm sure is yet not going to be particularly easy next few days. Adra Hauser, thank you very much for talking with us today and giving us some insights in this very difficult and volatile period. That's all for today's Politics podcast. Thank you to my producer, Ben Roper. We'll be back with another interview soon, but goodbye for now. Production by Ben Roper, theme music by Lee Roosevelt. The conversation is a not-for-profit media organisation. Sign up to our daily newsletter for evidence-based news and analysis, including articles from Michelle Gratton, or listen to more of our shows wherever you get your podcasts. Lovely to have you all here in Lundblesch. Hi, I'm Ashlyn McGee from the conversation and this is our daily news conference. Basically, there are only about four experts in the country that actually model how much it costs to raise a child. This is where our experienced team of journalists, pictures ideas about what's going on in the world, the latest research developments, or stories that just help you make sense of breaking news. 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