Governor Michele Bullock has been unusually frank about weak productivity, and equally frank that interest rates are not the tool to fix it.

Central bankers are not known for blunt language. So when Reserve Bank Governor Michele Bullock declared at her 29 September media conference that "The bottom line is that productivity is doing nothing," the remark stood out.

Just as notable was what she said next about her own institution's limits: "monetary policy can't do anything about productivity."

Those two comments, made on the day the Monetary Policy Board lifted the cash rate target by 25 basis points to 4.60 per cent, go to the heart of a tension in Australia's economic outlook. Weak productivity is making the RBA's job harder, yet it is not a problem the RBA can solve.

Why productivity matters to inflation

Productivity measures how much output the economy produces for each hour worked or each unit of input. When it grows, businesses can pay higher wages without necessarily lifting prices, because each worker is producing more. When it stalls, rising wages feed more directly into higher costs per unit of output.

That is the link the RBA keeps returning to. Appearing before the House of Representatives Standing Committee on Economics on 18 September, Bullock said: "Continued weak productivity growth means that the economy cannot grow strongly without putting pressure on inflation."

The Board's 29 September statement made the same point in different words, noting that weak productivity constrains potential growth. Potential growth is the pace at which the economy can expand without generating excess demand. When it is low, the economy hits capacity limits sooner.

The consequences show up in the cost data. The August Statement on Monetary Policy described unit labour cost growth of 3.3 per cent over the year to the March quarter as "elevated". Unit labour costs capture wages relative to productivity, so weak productivity tends to push them up.

What the central bank can and cannot do

Bullock's line about the limits of monetary policy reflects a basic division of labour in economic management. Interest rates influence how much households and businesses borrow and spend. They work on the demand side of the economy. Productivity, by contrast, is a supply-side matter, shaped by factors such as investment, technology, skills and how efficiently resources are used.

A central bank cannot raise or lower rates to make workers or firms more productive. What it can do, in Bullock's view, is create the conditions in which productivity has the best chance to improve. "The best thing we can do for productivity is get inflation low and stable," she said.

The reasoning is that high and uncertain inflation makes it harder for businesses to plan, invest and allocate resources efficiently. Stable prices provide a clearer environment for the kind of long-term decisions that tend to support productivity growth.

A lower speed limit, a tighter policy setting

Weak productivity helps explain why the RBA tightened in September even though growth has slowed.

  • The Board's statement said output growth has slowed but was stronger than expected in the June quarter.
  • It described business investment and debt growth as strong.
  • It listed capacity pressures in the economy among the upside risks flagged in August that were now materialising.

With a low speed limit, even moderate demand growth can push against capacity. The August minutes noted that spare capacity was expected to emerge only from late 2027, a sign that the Board expects the economy to remain stretched for some time yet. "Inflation is too high and has been driven by domestic capacity pressures," Bullock said on 29 September.

The inflation numbers reflect that. Headline inflation, measured by the monthly CPI indicator, was 4.0 per cent over the year to August. Over the year to the June quarter, headline CPI was 3.9 per cent and trimmed mean, the RBA's preferred underlying measure, was 3.6 per cent. Bullock described underlying inflation as "about 3.5 per cent", roughly a percentage point above the 2.5 per cent midpoint of the 2–3 per cent target range.

The Board judged that "a further tightening of financial conditions" was warranted to return inflation to target within a reasonable period.

Wages are not the villain

If productivity is weak and unit labour costs are elevated, it might seem that wages are the problem. The RBA has been careful not to frame it that way.

On 29 September, Bullock said: "I concur with his view that, no, this is not a wage price spiral." Monetary Policy Board member Iain Ross AO, speaking in a personal capacity at the University of Melbourne on 22 September, concluded that "there is no evidence of the emergence of a wage-price spiral in the present circumstances".

The August minutes did record that the near-term wage forecast had been "slightly upgraded" due to recent wage decisions and agreements, and the August Statement forecast Wage Price Index growth of 3.3 per cent through 2026 and into mid-2027, easing to 2.9 per cent by December 2028. Those forecasts were made with a cash rate assumption of around 4.3–4.5 per cent, before the September hike.

The issue, in the RBA's framing, is less that wages are growing too fast and more that productivity is not growing enough to absorb them.

The Board's statement paired its comments on productivity with a warning that uncertainty is high and that the effects of the housing downturn are uncertain. The Governor also noted that earlier rises are still working through, saying "A lot of that effect is still to flow through" and that policy can take "12, perhaps even 18 months" to have its full impact. On the outlook for rates, Bullock was clear: "I'm not going to give you forward guidance." She did say "The Board will increase interest rates again if that's what's needed to get inflation down." The next decision is at 2.30 pm on 3 November.

The bottom line

Bullock has drawn a clear boundary. Weak productivity is one of the reasons the economy cannot grow strongly without stoking inflation, and it is part of why the Board judged tighter policy was needed. But the RBA cannot fix productivity with interest rates. Its contribution, as the Governor sees it, is to get inflation low and stable, giving businesses a steadier footing for the investment and decisions that could lift productivity over time. The rest lies outside the central bank's reach.