‘Nightmare’: RBA’s inflation warning puts another hike in play

“The inflation outlook looks materially worse than we projected in the August report,” he said.

“[The] labour market is easing, consumption growth is quite tepid, but there are still pockets of growth, and the inflation outlook has deteriorated. So that’s a pretty tricky balance”.

Another increase would be the fifth this year and would take the official cash rate to 4.85 per cent, its highest level since 2008, an 18-year high.

Describing the decision as involving “hard choices”, Hauser acknowledged further tightening would carry economic costs.

“The challenge that’s facing the board and has done for some time is do you do more to tackle higher inflation, recognising that that means weaker activity, weaker labour market,” he said.

“Those are hard choices; they’re not where we’d like to be ideally as the central bank.”

Expectations raise the stakes

Hauser’s concerns extended beyond current price pressures to confidence in the bank’s ability to restore inflation to its 2–3 per cent target.

“We are beginning to see some signs that some people in the community are not sure if we’re going to bring inflation back into target at all, or certainly not for an extended period,” he said.

He cited research with Macquarie University showing more businesses considered above-target inflation “normal” and warned against allowing those expectations to become entrenched.

“That is the central banker’s nightmare. We can't allow expectations to shift away from target,” he stressed.

Although unemployment reached a five-year high in September, Hauser stressed it remained comparatively low.

“No lost job is one to celebrate. I would never say that, but these are still quite low numbers internationally and relative to history,” he said.

“The reason is that, even though we are laying shorter-term pain on top of pain, it's to prevent a longer and potentially far worse pain down the track if inflation expectations get locked in.”

Following his remarks, market pricing put November hike odds at 57 per cent, against below 20 per cent last week. The September-quarter inflation figures arrive on October 28.

Australia and New Zealand Banking Group (ANZ) and Westpac are forecasting another increase in November, while the National Australia Bank (NAB) and the Commonwealth Bank of Australia (CBA) tentatively judge the hiking cycle finished and are anticipating an extended hold.

Beyond mortgage repayments

Separately, RBA assistant governor Chris Kent challenged the emphasis on borrowers’ cash flow when explaining how interest rates affect the economy.

At CBA’s Global Markets Conference on Monday, Kent said exchange-rate movements could account for as much as two-thirds of monetary policy’s modelled impact on GDP and inflation.

Kent said the exchange rate’s contribution “quickly gets forgotten”, arguing other transmission channels deserved greater attention.

“All those [different channels of monetary policy] are working, and then the one that gets way too much attention – and we’ve said this before – is the cash flow channel,” he said.

In response to Kent’s remarks, Westpac chief economist Luci Ellis questioned the timing of the RBA’s increased emphasis on exchange rates.

“The real question is: why weren’t they talking about [the exchange rate channel] during the year?” Ellis said.

“They haven’t been putting consistent weight on that channel, but it is there.”

Meanwhile HSBC chief economist for Australia and New Zealand Paul Bloxham said the bank was challenging perceptions that cash flow was monetary policy’s dominant transmission mechanism.

“The reason the RBA is talking about the breadth of all the different channels is because they want to point out that actually this is just one of, and not necessarily even the largest, of the channels that affects the economy,” Bloxham said.

[Related: RBA finds borrowers resilient as economic pressures build]