Governor Michele Bullock has acknowledged how long inflation has been away from the Reserve Bank's target, and the Board says its priority is stopping that from becoming permanent.

Six years is a long time in economics. It is longer than many young workers have been in the labour force, and long enough for habits around pricing and pay to shift.

That is the span Reserve Bank Governor Michele Bullock pointed to at her media conference on 29 September. She said that "we have been outside of our target now for six years," speaking on the day the Monetary Policy Board raised the cash rate target by 25 basis points to 4.60 per cent.

The admission helps explain the urgency in the Board's latest statement, which said it is focused on preventing high inflation from becoming embedded.

Where inflation stands now

The RBA targets inflation of 2–3 per cent, with a midpoint of 2.5 per cent. Inflation has come a long way from its worst. As Bullock told the House of Representatives Standing Committee on Economics on 18 September: "Inflation fell significantly from its peak of 7.9 per cent at the end of 2022."

But it remains above where the Board wants it. It is worth separating the two main measures:

  • Headline inflation, which includes every item in the CPI basket, was 4.0 per cent over the year to August on the monthly CPI indicator, and 3.9 per cent over the year to the June quarter.
  • Underlying inflation, measured by the trimmed mean, was 3.6 per cent over the year to the June quarter. Bullock summarised it on 29 September as "about 3.5 per cent", roughly a percentage point above the target midpoint.

The Governor was careful to keep that in perspective. "Inflation is not in double digits," she said. But being a percentage point above the midpoint for an extended period is exactly the kind of situation the Board is wary of.

Why "embedded" inflation worries the Board

When inflation stays high for long enough, it can start to feed on itself. Businesses come to expect rising costs and build regular price increases into their plans. Workers and households expect higher prices and factor them into wage claims and spending decisions. Over time, a temporary problem can harden into a persistent one, and that is much harder and more costly to reverse.

The Board's 29 September statement flagged several warning signs:

  • short-term inflation expectations are high
  • recent inflation outcomes were stronger than expected
  • firms are raising, or planning to raise, their prices
  • capacity pressures in the economy are among the upside risks now materialising

Bullock added evidence from the RBA's discussions with firms. "Indeed, businesses in our liaison program continue to expect strong increases in their costs over the year ahead," she said.

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

What getting back to target looks like

Bullock offered a practical benchmark for what success would look like. Quarterly inflation, she said, needs to be "more around .6 rather than .8 and 1". A pace of about 0.6 per cent a quarter is consistent with roughly 2.5 per cent a year, right at the midpoint.

The RBA does not expect that to happen quickly. Before MPs in September, Bullock said "inflation will not return to around the midpoint of the target range until late 2027." The August Statement on Monetary Policy forecast headline inflation to return to the 2–3 per cent range by early 2027, while trimmed mean inflation was expected to stay above 3 per cent until mid-2027 and reach the midpoint in early 2028.

Those forecasts were prepared with a cash rate assumption of around 4.3–4.5 per cent, before the September hike, so they do not reflect the current setting.

On those projections, underlying inflation would remain above the top of the target range until around mid-2027, extending a run that is already long by the Governor's own account. That is part of why the Board is keen to ensure progress does not stall, and why it has said it will remain attentive to incoming data.

The cost of the cure

Higher interest rates are not painless, and the Governor acknowledged as much. "I know they don't understand why we have to do this and it hurts them," she said.

She also tackled some of the more alarming interpretations of the economic outlook. On recession, she said: "That is not our central base case at this moment." On stagflation: "I wouldn't call inflation of 3.5 per cent and an unemployment rate of 4.6 per cent stagflation."

The labour market has softened, but from a strong position. Bullock noted that "the unemployment rate has risen from 3.5 per cent over the past couple of years to 4.6 per cent", while "there's been over a million jobs created." She was also firm that the current situation is not a wage-price spiral: "I concur with his view that, no, this is not a wage price spiral."

In the Board's framing, the priority remains returning inflation to target within a reasonable period. Bullock also linked low and stable inflation to the economy's long-term health, saying "The best thing we can do for productivity is get inflation low and stable".

Policy also works with a delay. "A lot of that effect is still to flow through," Bullock said of the year's earlier rises, adding that it can take "12, perhaps even 18 months" for policy to work through fully.

Whether further rises follow is open. "I'm not going to give you forward guidance," the Governor said, though "The Board will increase interest rates again if that's what's needed to get inflation down." The September minutes are due on 13 October, the next CPI release on 28 October and the next decision at 2.30 pm on 3 November.

The bottom line

Bullock's acknowledgement that inflation has been outside the target for six years frames the Board's latest decision. Inflation has fallen well below its 7.9 per cent peak but remains about a percentage point above the midpoint on the underlying measure, with short-term expectations high and firms still anticipating strong cost increases. The Board's stated priority is to stop high inflation from becoming embedded, and the Governor has been candid that the process is painful for many Australians.