Reserve Bank Governor Michele Bullock says government spending is driving up inflation by adding to demand

Australia’s chief central banker Michele Bullock has told a parliamentary hearing government spending is driving up inflation in the wake of the first rate hike in more than two years and warned of another monetary policy increase if demand didn’t slow.

Hours after her appearance, Westpac became the latest big four bank to predict a follow-up rate rise in May.

Treasurer Jim Chalmers has been arguing that private sector activity is fuelling inflation and not public sector spending, with both headline and underlying inflation now well above the Reserve Bank of Australia’s 2-3 per cent target.

But the RBA Governor on Friday contradicted him, agreeing with a suggestion from Liberal MP Simon Kennedy that high government spending had pushed up inflation by increasing demand for goods and services.

“Yes, it does, because as you say there’s some public demand and then there’s transfers and taxes which also flow into that,” Ms Bullock told the House of Representatives economics committee in Canberra. “It’s all part of aggregate demand.

“Aggregate demand, we think, is currently in excess of the ability of the economy to supply those goods and services which are being demanded. Total demand is too high and that’s what’s giving inflationary pressures.”

She also warned of another rate rise if this didn’t slow.

“If we need to put up interest rates to slow the growth in demand, in aggregate demand, then that’s what we will do,” Ms Bullock said.

“I don’t have a view on the Treasurer’s words.”

Ms Bullock also admitted government spending decisions affected interest rates.

“Well, it does as does private. It’s part of aggregate demand,” she said.

She made the acknowledgement about government spending on Friday, after refusing on Tuesday “to comment on fiscal policy” when asked by journalists in Sydney about the link between government spending and inflation.

Federal Government spending is forecast by Treasury to hit 26.9 per cent of gross domestic product in 2025-26, which outside of COVID would the highest since 1986.

“Mathematically, you’re right. Public demand expenditure and private sector, all of that adds to demand,” she said.

“That’s logical. It’s mathematical. That’s what happens.

“It’s factual. It’s not an opinion. It’s not a judgement, it’s a fact. That’s all is it.”

Ms Bullock also confirmed that government expenditure often showed up in private demand, with some private activity reliant on government contracts or subsidies like discontinued electricity rebates.

“What it often does is it transfers money to people, and it gives them money to spend,” she said.

“Fiscal policy decisions are decisions for the Government and the Parliament; they are not for the Reserve Bank of Australia.”

RBA assistant governor Sarah Hunter said Federal Government spending was a factor, but said the Commonwealth alone wasn’t to blame.

“It’s a component of aggregate demand,” she said. “It doesn’t just matter what the Federal Government does. It does matter what the states do, what local authorities do even.”

The appearance of RBA officials before MPs is occurring three days after the Reserve Bank of Australia increased the cash rate by 25 basis points to 3.85 per cent, undoing the August cut and marking the first monetary policy tightening since November 2023.

“I recognise the challenges a cash rate increase brings for Australians with mortgages but it’s the right thing for the economy as a whole because we need to ensure inflation is low and stable so that households and businesses can plan, invest and create jobs,” Ms Bullock said.

“I’ve said it before but high inflation hurts all Australians whether you’re paying a mortgage, renting, running a business or just trying to make ends meet and it’s especially tough on people on lower incomes and those in more vulnerable situations.”

The RBA is expecting headline inflation to climb even higher to 4.2 per cent by June, up from an annual pace of 3.8 per cent in 2025, and remain above its 2-3 per cent target until at least mid-2027.

Headline and underlying, trimmed mean inflation were not forecast to fall back to the mid-point of the target band until late 2028, based on modelling of one or two more RBA rate hikes.

Westpac chief economist Luci Ellis, a former RBA assistant governor, changed her forecasts on Friday to predict a May rate hike.

“With inflation now higher (and overall demand growth stronger) than previously expected, the RBA raised the cash rate in February. The question then becomes, how much more is coming and when? We believe that another cash rate increase will occur, in May,” she said.

The futures market and National Australia Bank also are predicting a follow-up rate hike in May that would take the cash rate up to 4.1 per cent and reverse the effects of a May 2025 rate cut.

A rate hike just six months after a rate cut last occurred in late October 2009, following Global Financial Crisis stimulus that included $900 cheques to Australians. Last year’s three rate cuts marked a shallower easing cycle in the 36-year history of the RBA publishing a target cash rate.

“I think it points to the fact that we have managed to get the economy into a reasonably good place and we always thought it would be tricky when we were sort of in a neutral position,” Ms Bullock said.

“We didn’t know whether we were tight or lose or so on. It reflects the fact that we’ve been trying very hard to bring the economy down on a soft landing. It would have been very easy to bring the economy to its knees: just increase interest rates a long way.”

While the peak cash rate of 4.35 per cent in late 2023 was lower than it was in the US, UK, Canada and New Zealand, borrowers had copped more rate increases in 18 months than had previously occurred in a little more than a decade.

The RBA has increased interest rates 13 times now on Labor’s watch since Anthony Albanese came to power in May 2022, after being at record lows of 0.1 per cent during COVID.

This is more than the nine increases when Labor was last in power under Kevin Rudd and Julia Gillard from 2007 to 2013.

The cash rate rose 15 times during John Howard’s time as Liberal prime minister from 1996 to 2007, but it took more than a decade for rates to go up 13 times.