AARON PATRICK: Why Reserve Bank governor Michele Bullock has to be a psychologist and economist

Last September, a month after it had cut interest rates for the third time in a year, the Reserve Bank of Australia realised it had a serious problem.

The central bank’s economists began to appreciate their most important assumption was wrong. Official interest rates, which their board had cut to 3.6 per cent, weren’t operating as expected.

Rates weren’t dampening inflation. They may have been making the problem worse. Inflation had fallen to 1.9 per cent by June. Two months later it was at 3.2 per cent — a 68 per cent increase. Still, the Reserve Bank’s board, which relied on a different time period measuring price rises, decided to implement one more cut that month.

Over the rest of the year Australians watched, and suffered, as inflation continued to rise, mocking the celebratory mood that had greeted the Reserve Bank’s inflation victory lap.

Caught out

On Thursday, a senior-but-little known Reserve Bank official conceded they had been caught out. In a speech explaining how the central bank had changed views on interest rates, Assistant Governor Christopher Kent said “financial conditions in the second half of last year had been less restrictive than previously thought”.

One unexpected reason cited for the shift was something that might have been obvious. Intense competition had driven down home mortgage costs even further than official interest rates, making it cheaper to buy houses and apartments with debt. The extra money in peoples’ bank accounts was being spent on holidays, restaurants and other luxuries, overheating a stretched economy.

Dr Kent said the a-ha moment came a month after the last interest rate cut, a cut that now looks like a mistake.

“From around September 2025, however, the weight of evidence began to shift, suggesting that financial conditions were no longer restrictive enough to return inflation to target in a reasonable time,” Dr Kent told a debt industry conference in Sydney.

“Against that backdrop — and the broader signs of rising inflationary pressures — policy was tightened in February and March to help bring down inflation.”

Overly optimistic

Some independent economists suggest the Reserve Bank tried to be too heroic. Unlike many other Western countries that cracked down hard on the post-pandemic inflation wave that swept the world, the Reserve Bank prioritised keeping people in work.

While rates were falling and unemployment low, everyone was happy: the government, financial markets and regular Australians.

Now a war and energy shock are turbo-charging what was already a serious inflation break-out, the Reserve Bank is being forced to drive rates back up. Financial markets predict they will hit 4.6 per cent this year.

“They were over-optimistic on what they could achieve and they should have shown more planning,” former Reserve Bank head of economic research John Simon told The Nightly.

To be fair on the Reserve Bank, the inflation fight is made harder by the Albanese government. By spending more than it raises, the government increases pressure on an economy that can’t keep up with the demands placed upon it.

Reserve bank losing confidence game

That leaves Reserve Bank governor Michele Bullock with two really tough jobs: psychologist and economist.

Not only does she have to slow inflation across the economy — incredibly difficult when oil and other important prices are set overseas — she has to rescue Australians from the self-fulfilling cycle of inflation expectations. In other words, she has to make workers and businesses believe prices won’t go up.

At this point, the Reserve Bank is losing the confidence game. Inflation has been above the central bank’s 2-to-3 per cent target since June, 2021, with the exception of last year’s mirage.

As HSBC economist Paul Bloxham wrote in the financial press today, “If the RBA never actually achieves its 2.5 per cent target, why would people continue to believe that it will?”