Received

Businesses should not contribute to soaring inflation by taking home oversized profits, the head of the Reserve Bank warns.

While RBA governor Philip Lowe stopped short of accusing businesses of gouging under the cover of inflation, he told a parliamentary committee elevated profit margins could become a major contributor to inflation.

Dr Lowe said there were three broad drivers of inflation - higher input prices, higher wages and higher profit margins.

"Today, (inflation) is largely from higher input costs," he told a House of Representatives economics committee on Friday.

"There's some pickup in wages but that's not driving inflation - and I think in some industries there has been an increase in margins."

Dr Lowe said it was not surprising firms were keeping prices high in current conditions.

"...many firms say to me they want more workers, they don't want more customers at the moment," he said.

"And when that's your mindset, you've got to push your margins up. It would be kind of strange if you didn't."

However, he said that process shouldn't go too far.

"I don't think it has at the moment, but it's just kind of sounding a warning," he said.

Dr Lowe said wages would have to remain subdued to avoid a wage-price cycle in which high inflation leads to higher wages that subsequently drive higher inflation.

"This type of cycle would lead to higher interest rates, a weaker economy and higher unemployment," he said.

"Businesses do have a role in avoiding these damaging outcomes by not using the higher inflation as a cover for an increase in their profit margins."

Dr Lowe said the troubles facing the global economy made it harder for the Reserve Bank to navigate a soft landing for the Australian economy.

He said higher-than-expected inflation figures in the United States and deteriorating economic conditions in Europe and China made it difficult to return inflation to the two to three per cent target and keep the economy on an "even keel".

"I think it is possible to achieve this but the path here is a narrow one and it's clouded in uncertainty," he said.

Dr Lowe used his opening speech to address concerns about the RBA's response to pandemic-era challenges.

"In those dark days of the pandemic, the Reserve Bank board judged that the bigger policy mistake would have been to do too little rather than too much," he said.

"If the worst had occurred, Australians would have paid a heavy price."

Dr Lowe defended the bank's earlier commitment to low interest rates until 2024.

"I'm frequently reminded that many people interpreted our previous communication as a promise or as a commitment that interest rates would not increase until 2024 - this was despite our statements on interest rates always being conditional on the state of the economy," he said.

Future cash rate decisions would depend on inflation expectations and how general inflation psychology evolved in Australia, he said.

Since May, the RBA has lifted its cash rate target from 0.1 per cent to 2.35 per cent, which has added more than $600 a month to the average mortgage holder's monthly repayments.

© AAP 2022

Another interest rate hike is all but locked in, but the Reserve Bank of Australia has not ruled out a slower pace of tightening.

RBA governor Philip Lowe said the 2.35 per cent cash rate was "still on the low side" but suggested between 2.5 and 3.5 per cent as a "neutral" cash rate range.

"We're closer to a normal setting now, which means that the case for large adjustments in interest rates is diminished," Dr Lowe told a House of Representatives economics committee on Friday.

At the next rate decision in October, he said the board would likely be choosing between a 25 basis point increase or 50 basis points.

Since May, the RBA has lifted its cash rate target from 0.1 per cent to 2.35 per cent in an effort to tame inflation, which has added more than $600 a month to the average mortgage holder's monthly repayments.

Informing these decisions will be the state of the global economy, how wages and prices are adjusting to inflationary pressures and household spending habits.

Dr Lowe said wages would have to remain subdued to avoid a wage-price cycle in which high inflation leads to higher wages that subsequently drive inflation higher.

"This type of cycle would lead to higher interest rates, a weaker economy and higher unemployment," he said.

He also said the central bank was relying on rising interest rates to slow growth and put downward pressure on profits, and warned businesses not to take home oversized profits.

"Businesses do have a role in avoiding these damaging outcomes by not using the higher inflation as a cover for an increase in their profit margins."

Dr Lowe acknowledged wages growth falling behind inflation and modest profit margins were painful, but said the short-term discomfort was necessary.

"So this year, wage growth is much less than the inflationary and that's really tough for people.

"But if we if we hold together on these two things ... next year we can look forward to growth in real wages again."

The alternative, he said, was letting inflation spiral out of control.

The RBA governor also commented on the role of fiscal policy to help support the economy.

While he had no particular concerns about the October federal budget, he said the government should consider tax reform and other structural changes "so the pie is bigger".

"The community wants all these things from our governments, which is understandable," he said.

"What we haven't worked out as a community is how to pay for it, and this is why we've got these budget deficits despite full employment and the record terms of trade."

In an opening speech, Dr Lowe defended the bank's earlier commitment to low interest rates until 2024.

"I'm frequently reminded that many people interpreted our previous communication as a promise or as a commitment that interest rates would not increase until 2024 - this was despite our statements on interest rates always being conditional on the state of the economy," he said.

In some concluding remarks, he said the bank would stick with its formula for future cash rate decisions.

"Good decision-making is a continuation of putting these various factors together and trying to make what I'd say are very difficult decisions that affect people unequally, and we know are making some people very unhappy," he said.

© AAP 2022

The troubles facing the global economy are making it harder for the Reserve Bank to navigate a soft landing for the Australian economy.

RBA governor Philip Lowe said higher-than-expected inflation figures in the US and deteriorating economic conditions in Europe and China were making it hard to return inflation to the two to three per cent target and keep the economy on an "even keel".

"I think it is possible to achieve this but the path here is a narrow one and it's clouded in uncertainty," Dr Lowe told the House of Representatives economics committee on Friday.

Dr Lowe used his opening speech to address concerns about the RBA's response to pandemic-era challenges.

"In those dark days of the pandemic, the Reserve Bank board judged that the bigger policy mistake would have been to do too little rather than too much," he said.

"If the worst had occurred, Australians would have paid a heavy price."

Dr Lowe defended the bank's earlier commitment to low interest rates until 2024.

"I'm frequently reminded that many people interpreted our previous communication as a promise or as a commitment that interest rates would not increase until 2024 - this was despite our statements on interest rates always being conditional on the state of the economy," he said.

Future cash rate decisions would depend on inflation expectations and how general inflation psychology evolved in Australia, he said.

The RBA is facing a separate independent review that will scrutinise everything from its core objectives to its communication skills.

The review, introduced by Treasurer Jim Chalmers, has been welcomed by shadow treasurer Angus Taylor, although he warned against distracting the central bank from its core mandate of controlling inflation.

Since May, the RBA has lifted its cash rate target from 0.1 per cent to 2.35 per cent, which has added more than $600 a month to the average mortgage holder's monthly repayments.

© AAP 2022